2008 December

Limiting Your Losses

Because this is so important, I will make this a series of post and create a "category" for this particular topic. Sometimes when you are new to something, its hard enough to developing a trading plan when you have to do so many other things also. Trust me though, this has got to be up there with one of the most important rules that you must have.

Now, plenty of traders can trade from the "seat of their pants" and it may seem that they do it that way with very little effort. But it takes awhile to get to that point and with 90% of traders failing, you may not have that much time.

Many of you who are learning how to trade futures, came to the decision to trading futures for the money. Whether you’ve read it in a book or ebook, someone told you about it or you’ve seen some sort of advertisement about futures trading, the one thing that pulled you in to futures trading is the amount of money you can make trading futures.

While I know this to be true, I hear and talk to many traders who are already placing undue pressure on themselves saying that they will make "x amounts" of dollars per day, week or months. First I wouldn’t be thinking about that part just yet. Learning how to trade and profit consistantly can take awhile. Even if you are like me, and profited early on in your commodity trading career.

Before you make plans on how you are going to spend your riches, let’s come back to earth for a second and find out how much can you afford to lose.

Why? Well, losing is part of futures trading. If there is one thing that I can guarantee will happen once you start trading futures is….you will lose at some point. The question now is just how much!

Since much of analysis will be based on probabillities for profit targets, what is directly in our control is how much money can you lose. So let’s look at ways to limit those losses. It should be a maximum of one loss per day.

Once you’ve established a position, than you would need to determine where you are going to place a stop loss. Although stop losses can be based on technicals of support and resistance, let’s just make it simple and use a 5% money stop loss.

Now what is 5% represent.

Good question. On a $5,000 dollar account, 5% risk would mean I risk about $250 dollars per trade. On a $20,000 dollar account 5% would equate to $1,000 dollars. As you can see this is a major difference. This is why it is important to trade as large as you can. But life sometime doesn’t put you in that position so you gotta deal with what you have. If you start with less than $5,000 dollars you may have to risk more since placing a 5% stop loss may equate to a stop loss that is too close. Understand by doing this, lessens your chance of succeeding. About $250-$300 dollars as a money stop loss would be ideal.

By only risking 5% the theory is that you have 20 times to make money before being "wiped out". Hopefully this won’t happen.

As the market moves in your favor, I would looking at tighting your stop loss order to a 3%-4% percent risk (stop loss). By doing so, you have just added some life to your trading account. Maybe another 10 losses.

You won’t always have this ability to this because there are times where you will just lose and it is good to limit those losses to 5% or less.

Another good way to sound money management is to wait for a true futures trading setup and not just to trade for the sake of trading. By waiting you can actually learn how the market moves during regular trading hours (RTH) or the Day Session Hours. Usually this is when you have the most volume and the market is most liquid. And again, save your trades for the best possible trading setups.

It is also the time when you could get a real feel of the market. Learn what the daily trading range is and how well does the market trend. This is all important to your overall success.

The last trading tip to limiting your losses when trading futures is, when you hit your 5% loss for the day, shutdown the computer and walk away from trading for the day. You don’t know how many times after losing my limit for the day, that I went back and tried to "double down" and I eventually lost more money, thereby lessening my chances overall of succeeding.

Remember, at most you have between 20 a 30 losses until you get "wiped out" based on a $5,000 dollar account. One 5% loss per day is enough money to lose so do yourself a favor and shutdown your trading software, shutdown your computer and do something else.

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