Techno Finance and Executive Diary...

Thursday, October 04, 2007

The Risk of Futures Trading

Before becoming too excited about the substantial returns possible from futures trading, it is a good idea to take a long, sober look at the risks. Reward and risk are always related. It is unrealistic to expect to be able to earn above-average investment returns without taking above-average risks as well.

Most people are naturally risk averse. They don't like to take big risks, especially financial risks. Perhaps you can relate to the point of view of humorist Will Rogers: "I am not as concerned about the return on my money as I am about the return of my money."

Futures trading has the reputation of being a highly risky endeavor. It is true that a high percentage of traders eventually lose money. Many people have lost substantial sums.

However, futures trading's reputation as a highly risky activity is somewhat undeserved. Think of yourself walking into your favourite gambling casino. You decide to play roulette. The table has a 5 minimum bet and a 5,000 limit, which happens to be your total risk capital. If you place a 5,000 bet on red, you should not be surprised if you immediately lost your 5,000. On the other hand, if you made only 5 bets, you could play for a long time and probably not lose very much at all.

Futures trading is the same in the sense that the individual is the one who decides how he wants to operate. He can make large bets or small ones. One can trade futures carefully and risk as little as 1-2% of your trading capital on a single trade. You could trade a long time this way and not lose your entire trading capital. However, most people are not that patient. The unfortunates who lose big are those who can't control themselves. They take big risks and risk a large portion of their trading capital in an attempt to get rich quick.

One important quote about trading comes from trading psychology expert Mark Douglas. As he points out, most of us are not as willing to take financial risks as we think: "Most people like to think of themselves as risk takers, but what they really want is a guaranteed outcome with some momentary suspense to make them feel as if the outcome had been in doubt. The momentary suspense adds the thrill factor necessary to keep our lives from getting too boring."

Futures trader's should be fully aware of and be comfortable with the risks involved. Managing the risks of trading is a very important part of any trader's success. Although the risks can be managed, they can never be eliminated. Remember that the high returns successful speculators can earn are available only because the speculator is being paid to take risk away from others.

Another thing to understand about risk in trading is that you cannot avoid losses by careful planning or brilliant strategy. Numerous losses are part of the process. In The Elements of Successful Trading, Robert Rotella puts it this way: "Trading is a business of making and losing money. Any trade, no matter how well thought out, has a chance of becoming a loser. Many people think the best traders don't lose any money and have only winning trades. This is absolutely not true. The best traders lose a lot of money, but they eventually make even more over time."

There is no point trading if you cannot handle the psychological discomfort of making losing trades. While people tend to take losses personally as a sign of failure, good traders shrug them off. The best trading plans result in many losses. Because of the amount of randomness in market price action, such losses are inevitable.

Labels: Forgotten Facts, Stock Market

Posted by "CPerformance" :: 12:05 AM :: 0 comments