Risk Management is Imperative when Trading in Commodities
The "meat" of a proper futures trading plan is risk management. This is concerned with establishing thresholds of loss that you are capable and willing to accept in exchange for potential rewards. In the case of futures traders, this may simply mean picking a stop loss price and placing the order in conjunction with a profit target (limit order).
Once again, trading plans are for guidance and shouldn't be followed blindly. Don't be the futures trader that misses taking a healthy profit while trying to squeeze out an extra $20 because the price came within ticks of a working limit order but failed to trigger. Also, even if your trading plan doesn't involve a trailing stop don't be a fool. Markets don't go up or down forever, if you have a large open profit tighten your stop loss order, or place protective options or option spreads and walk away.
Managing Commodity Market Risk is an Art not a Science
Creativity can be a valuable tool in futures trading. Think beyond the traditional practice of using stop loss orders to manage risk, because there are an unlimited number of possibilities. For instance, experienced futures traders might choose to incorporate selling option premium against a correctly speculated futures contract as a form of risk management. Doing so converts the trade into a type of “covered call” or “covered put”. The premium collected from the short option not only produces income, but it provides a hedge against a price reversal. This is because a long futures contract and a short call option benefit when the market moves in the opposite direction (they counter act one another). Likewise, in-line with this strategy you may want to use the proceeds of the covered call or put strategy to purchase an option to protect your risk of an adverse futures price movement.
As you can see, well-informed traders have a plethora of strategies to adjust the risk and reward of a futures position. A trading plan couldn't possibly cover all market scenarios, and adjustment possibilities, but writing down a few potential ideas may keep you from freezing in the heat of the moment.
If you are interested in exploring the endless possibilities in regard to futures trading management, and strategy creation, please visit our futures and options trading educational video archive.
Risk and Reward: Give Yourself a Chance!
When deciding how much risk you are willing to take in the commodity markets and setting your profit objectives, you must be realistic. Beginning futures traders are often surprised to hear that many of the best traders struggle to keep their win/loss average above 50%. With these odds in mind, it doesn't make sense to consistently risk more on a trade than you hope to make should you be right. For instance, if your average risk is $500 you should have an average profit target of at least $500. Anything other than this puts the odds greatly in favor of your competition.