The Commodity Trading Game Plan

 

 

Leave Multiple Contract Trading to the Pros and Well Capitalized



As a long-time commodity broker, one of the most destructive things that I have witnessed traders do is execute multiple futures contracts in a moderately funded account. Inexperienced traders are under the assumption that trading several futures contracts simultaneously will maximize their "return", but what they are actually doing is maximizing risk and minimizing the probability of a successful trade. Despite the emotions involved, commodity trading isn't about feeding your ego it is about making money...right?



Stop the Loss!



Stop Loss Order in FuturesFutures traders often look to manage risk of loss through the use of stop loss orders. A stop order instructs the broker to exit an outstanding futures position if market prices move adversely enough to reach the named price. However, keep in mind that a stop order can also be used to enter a market. Such a stop order is often placed above areas of significant technical resistance or below support in an attempt to capitalize on a potential price break-out.

In order for stop orders to be effective, they must be properly placed. Anything less will result in either too much risk, or premature liquidation of a trade that may eventually go in favor of the position. This too is an art and not a science. Where stop orders should and shouldn't be placed isn't a black and white decision. There are many areas of gray involving market conditions and characteristics as well as the personality, account funding and risk tolerance of the commodity trader.

If you are a beginning trader this may be a good argument in favor of using a full service commodity broker. However, you must realize that even a well experienced futures broker or advisor can't see into the future and is subject to the same frustrations as you may be. Nonetheless, in theory she may be a little more savvy, and that could have a positive impact on performance in spite of the slightly higher commission rate.

Be warned, stop orders aren't a guarantee of risk. Because a stop order becomes a market order once the stated price is reached, there may be slippage; in rare cases, a substantial amount of slippage. An experienced commodity broker might be able to help you in constructing an option strategy to be used as an alternative in risk aversion. The use of options in place of stop loss orders provide traders with additional lasting power because it eliminates the possibility of being stopped out of a commodity market on a temporary price spike. For example, a short option or futures position may be hedged by a one by two ratio write if the volatility and premium allows.

The ability to place a stop order or limit the risk of a futures trade through options and option spreads should eliminate some of the stress and emotion involved in trading. Rather than losing sleep over a trade gone bad, those with stop orders or protective option positions (insurance) can relax knowing that he has done his homework and has mitigated his risk in commodity trading.

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