Developing A Trading Plan - Pt 2

3. Risk Management

The most common mistake made by futures traders is the lack of any systematic risk-management. The high leverage and high volatility of the futures markets usually have a strong influence on a traders emotions. This emotional volatility results in a lack of objectivity and poor decision making. Have RESPECT for leveraged markets. The MARKET IS ALWAYS RIGHT. The aim therefore, is to devise a systematic approach and define in detail, parameters of a risk-management system. Under such a system, profits, and in particular losses, are defined and stop-loss orders are placed.

ALWAYS USE STOP LOSSES!

Its purpose is to attempt to limit your loss. However you must be aware that there is no guarantee that your stop loss order will be filled at your price. Don’t use mental stops - mental stops get moved.

Absolutely, positively do not remove or move your stop-loss father away.

Place stops on the basis of how much money you are willing to lose on each trade. This amount is always a percentage of the equity in your account. Most professional traders never risk more than two - three percent of capital on any given trade. Figure your stop losses ahead of time when you have a clear head and are not thinking crazily because the trade is going badly. Do not move your stop loss unless you have a profit and then move it only as a trailing stop.

Design your exit strategy up front, before the trade is even initiated. When you put on the trade, use an OCO (One Cancels the Other) order and enter both a protective stop and a profit target stop. Placing a money management order such as this in a quiet time of contemplation stops you from making emotional decisions during the heat of battle. If you hear yourself saying “I promise I will liquidate the position of this loser when it comes back to where I bought it” then it is probably to late. The market doesn’t know or care where you got in! Some traders fall into the trap of getting “married” to a position finding it hard to unwind the position when it goes against them.

Respect Price - Price is a loaded gun that can go off in either direction. Don’t get caught up with what a trader, a report or a news item says it should be doing. You must respect what price can do! Never buy just because the price is low or sell because the price is high.

4. Diversification

Diversification is the key to any trading plan. Look at a number of markets with one program or have a number of different programs for one market allowing for increased versatility in varying market conditions. It’s well documented that dividing capital among unrelated markets can reduce risk. For example Program A, may only provide signals in a certain market type, whereas Program B may provide signals in other market types. Strict control of trading capital is possible with the application of basic common sense principles. Concentrate and focus on a few select markets and completely master them - this is the tendency of professional traders.

You should not have a trading plan that calls for putting on multiple contracts if that means you have to use most of your money for margin. Your first trading rule should be to protect and preserve your trading capital. The name of the game is to survive so you are around to take advantage of any market opportunities.

5. Money Management

The principles of money management and risk control are perhaps the most important issue that any trader will face. Put simply, unless traders know how to manage their money correctly and keep their losses to a minimum, their career as traders are sure to be short lived.

Money management is mandatory.

Money management is critical to not only succeeding in the market but also staying in the market. Like all aspects of trading there are no hard and fast money management rules. Money management can simply be defined as `how much capital to risk?' and `how many contracts to trade?”. This is one of the most crucial concerns a trader faces; it determines your risk and profit and is often a technique neglected by traders.

The belief is that the markets will reward us with profits in due course and that we cannot force profits from the markets in the interim. You cannot predict the future, merely enable yourself to align with the current `line of least resistance' and therefore increase the overall probability of success.

Continued in Pt 3....