Commodity Futures and Options Trading- Money Management, Risk and Trading Logic, PART 4

Commodity Futures and Options Trading- Money Management, Risk and Trading Logic, PART 4 by Thomas Cathey

Possibly the most important aspect to get right in trading is survival. This is number one. Without surviving the bad times we are gone, with no hope. Money management and risk may sound like boring subjects, but read on to see how exciting they can be once you learn the concrete reasons and logic for their use. You may never trade the same way again!
There are commodity futures and option traders who make multi-millions every year. Some have been known to earn several hundred million a year. They consistently make a great living, to say the least. And there are traders who consistently lose. Commodity trading is a big arena, just like the stock market.

I used to wonder why the CFTC didn't come down hard on commodity firms and brokers who consistently lost money for clients. I thought that if it was any other kind of business, wouldn't the consumer protection or some government authority shut them down?
Then it dawned on me. This is a zero sum game! It's actually a negative sum game when commissions and so called "exchange, transaction, etc." fees are added in. For every commodity trader long there is someone short. For every winning uptick for one trader, there is a losing uptick for someone else.

So this means that half of the money must be lost by somebody if half are winners. Or 95% of the money is lost by commodity traders who give it to 5% of the prosperous others. With a zero sum game, there MUST be many losers, and some big losers if there are big winners. If the CFTC did an audit of a commodity brokerage firm, they could well EXPECT to come in and find brokers with customer accounts that are doing poorly. Brokerage commissions and profits won by the best traders must come from somewhere.

This is normal and the way the futures markets (and stock markets to some degree) have worked for over a century. As long as everything was done legally and ethically, there is no problem with customers losing. There is always a winner and loser in commodities. The same with Las Vegas. Vegas is also a negative sum game, given the house odds. The casino house is equivalent to the best commodity traders. (and brokerage houses, of course)
Interestingly enough, theoretically, an exception is the stock market. You could have 100% winning traders if everyone were long and all the stocks kept going up. Even the commissions could be covered. But this is never the case in the real world. There is probably no difference in losing statistics for stock or commodity speculators. It's a strange arena, this trading. You simply must remember that it is YOU against the competition. And there are sharp traders out there. Pure capitalism. You must make it as difficult as possible for them to take your commodity account money away.

Bottom line: When your commodity trading method's accuracy is low by design, you MUST let your profits run bigger than losses and limit your losses in order to be profitable to survive over the long haul. You should also never risk more than 5% to 7.5% on any one trade. When trading accuracy is high by design, you can then let the profit to loss ratio get closer to 1:1, take quicker profits and slower losses and risk up to 10% a trade. Remember that your goal is eventually to risk 5% or less a trade, as many professionals do.

Five of Five Parts - Next!
There is substantial risk of loss trading futures and options and may not be suitable for all types of investors. Only risk capital should be used.

About the Author
Thomas Cathey - 27-year trading veteran heads the managed futures division of Thomas Capital Management, LLC. View his market forecast TimeLine Trading charts and get his complete 44+ lesson, "Thomas Commodity Trading Course - all free."