Any fool can get into a market, but it's the real trading pros who know how and when to get out.

- Jim Wyckoff

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Are You Properly Managing Your Risk When Trading?

A successful trading plan must include a sound money management plan. RJO Futures' helpful guide on The Basics of Risk Management presents a valuable collection of articles on money management, as it relates to constructing a successful trading plan. You can gain a better understanding of risk control, position size, stop placement, and more.

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Hello again Fast Break readers. It's my mission to ensure that after reading my reports, you will take away at least one valuable trading "nugget" that will enhance your own trading methodology. In this educational feature, I will discuss the very important topic of money management.

I tend to harp on the subject of sound money management in futures trading -- and for good reason. Most professional traders and trading educators agree that the single-most important factor in futures trading success is using good money-management principles. It's not trying to obtain a higher winning percentage in trades, or cramming your brain with more trading tools, or buying the best trading software on the planet.

Indeed, a trader can possess tons of trading tools -- either by purchasing gigabytes of computer software or reading stacks of books. He or she can sign up for all of the market gurus, get real-time price quotes, and get the latest fundamental news hot off the wire services. But if the trader does not have a good money-management plan in place for trading futures, he or she may as well hang it up right now, because any trading success will only be fleeting (if even that).

Sure, one still has to be savvy at chart forecasting and/or fundamental analysis, but it's the money-management factor that will make or break a futures trader. The huge leverage involved with trading futures absolutely requires astute money management.

It may be that my conservative trading nature makes me even more of a money-management advocate than most. It's no lie when I tell you that even if I get stopped out of a losing trade and I have followed a trading plan "to the T" (including my money-management strategy), I am satisfied with that trade. You should strive for that thought process in your trading too -- and not only because of the good money-management aspect, but also because of the all-important trader psychology aspect. (I won't discuss trader psychology in this feature, but have written about it extensively in the past.)

Over the years, I have listened to the best traders in the world talk about what makes them succeed in this challenging arena, and nearly every one emphasizes the importance of sound money management. A few years ago, I attended a TAG (Technical Analysis Group) trader's conference in Las Vegas with the best traders in the business in attendance. One of the featured speakers stressed that "becoming a successful futures trader should be more an act of survival than scoring winning trades." Indeed.

Surviving as a futures trader first and foremost requires practicing sound money management. Even a rookie trader who starts out with a hot hand will eventually find that at least some trades are not going to go his way. And if he has not employed good money-management principles on those losing trades, he will likely have squandered his trading profits and his entire trading account.

Conversely, the novice trader who uses good, conservative money management techniques will be able to withstand some losses and be able to trade another day. The ability to take a loss and trade another day is the key to survival -- and ultimate success -- in the futures trading arena.

Here's an important point to consider, regarding money management and successful futures trading: Most successful futures traders will tell you that they will usually have more losing trades than winning trades during the span of a year. Then why are they successful? It's because of good money management. On the balance sheet, a few bigger winning trades will more than offset the more numerous smaller losers.

One of the most important money-management tools in futures trading is the use of protective stops. Successful traders set tight stops to get out of losing positions quickly, and they let the winners ride out the trend and employ trailing stops. If a trader sets a protective stop upon entering a trade, he or she knows about how much money is at risk for that trade. This is important, because the risk-management decision is made when the trader is not in the trade and not "in the heat of battle."

"Good money management" is a relative principle. A good money-management practice for one trader may not be a good money-management practice for another. Here's a real-life example: I had a fellow email me, saying he was up $3,000 in a sugar trade, and that his total trading account was $4,000. Although I don't provide specific trading advice to individuals, I told the trader that if I had only $4,000 in a trading account and had racked up three grand in profits on one trade, I would think about ringing the cash register and building up my account -- so that I could withstand those drawdowns and losers that will eventually occur.

On the other hand, if a trader with a $30,000 account had a $3,000 winning sugar trade, he may want to let the winner ride a little longer. Pocketing the profit would not nearly double his trading account size, as it would the smaller-capitalized trader.

In other words, don't be a greedy trader. There's an old trading adage that says there is room for bulls and bears in the marketplace, but pigs get slaughtered.

Let me emphasize here that there is nothing wrong with starting out with, or keeping, a smaller-capitalized futures trading account. But I strongly suggest that those smaller accounts use the very strictest of money management.

There are dozens of good futures and stock trading books available, and most spend at least an entire chapter on money management.

Here are just a few very general money-management guidelines:

• For smaller-capitalized traders, don't commit more than one-third of your trading capital to one trade. For medium- and larger-capitalized traders, you should not commit more than 10% of your capital to one trade. The guideline here is: The larger your trading account, the smaller your commitment should be to one trade. In fact, some trading veterans suggest larger trading accounts should not commit more than 3%-5% of their capital to one trade.
  
  Smaller-capitalized traders, by necessity, have to commit a larger percentage of their capital to one trade. However, these small-cap traders may want to trade options (buying them, not selling them), as risk is limited to the price paid for the option. Or smaller-capitalized traders may want to trade the smaller mini futures contracts.
  
  
• Never, never, never add to a losing position.
  
  
• Your risk-reward ratio in a futures trade should be at least 3:1. In other words, if your risk of loss is $1,000, your profit potential should be at least $3,000.

Below I have encapsulated some of the above information and added to it to create my "Top 10 Money Management Rules."

Jim Wyckoff's Top 10 Money Management Rules

1. Bulls make a little. Bears make a little. Pigs get slaughtered. In other words, do not be a greedy trader. If you are a bull, don't expect to get in at the bottom and out at the top. If you are a bear, don't expect to pick an exact market top and ride a market all the way down to the lowest low. Thinking otherwise allows the destructive "greed" emotion to take over. Greed has been the ruin of many traders.

2. Any fool can get into a market, but it's the real pros that know when to get out. Indeed, market entry is certainly an important element of successful trading. However, exiting the trade is paramount. Many times, a traders will allow a market to "go against" him or her for way too long and way too far -- meaning big trading losses. See Rule 3.

3. Use protective buy and sell stops. One of the major mistakes many traders make is not using protective buy and sell stops when they enter a trade. Or traders may pull their protective stop, "hoping" the market will turn in their favor. Don't be fooled into using "mental stops." Determining where to place protective buy and sell stops before market entry is one of the best money-management tools available.

4. Don't put all of your eggs in one basket. Using a large percentage of your entire trading account for one trade is unwise. Remember that even professional traders will have more losing trades than winning trades over time. The key to success is minimizing losses on the more numerous losing trades and maximizing profits on the fewer winning trades. See Rule 5.

5. Cut losses short; let winners ride. Using a predetermined protective buy or sell stop will cut your trading losses short. Using a trailing protective stop on trades that become profitable will allow you to maximize profits on the winning trades.

6. Only the markets know for sure. Don't ever think you "know" what a market will do at any given point in time. One of the biggest advantages for sound money management is "knowing that you don't know" what a market will do at any given time. A recipe for trading disaster is thinking you know what a market will do. Remember the old trading adage: "Markets will do anything and everything to frustrate the largest amount of traders."

7. Be humble. When trading profits are taken, be glad that it was not a trading loss. Don't grouse because you left a bunch of money "on the table," after you exited your winning position.

8. On selling options, use caution. There are some traders who do sell options on futures (as opposed to buying options) and make profits doing it. And there are many traders that don't. I heard a veteran speaker at a trading seminar once say: "I made over 40 trades selling options in a year, with 97% winners -- and still lost money." Remember the old saying that if it sounds too good to be true, it usually is.

9. Don't over-trade. Trying to trade too many markets at one time is not good money management. If you run into a losing streak, cut down on trading. Do not try to trade more markets just to quickly recoup lost money.

10. To succeed at trading markets, one must first survive at trading markets. Be conservative with your trading account and trading methods -- especially if you are a less experienced trader. Go for those "base hit" trades, and don't swing for the fence and try to hit a home run in a trading decision. Traders need to survive to trade another day, if they absorb a few losing trades.

The risk of loss in trading commodity futures and options can be substantial. Before trading, you should carefully consider your financial position to determine if futures trading is appropriate. When trading futures and/or options, it is possible to lose more than the full value of your account. All funds committed should be risk capital. Past performance is not necessarily indicative of future results.

Are You Properly Managing Your Risk When Trading?

A successful trading plan must include a sound money management plan. RJO Futures' helpful guide on The Basics of Risk Management presents a valuable collection of articles on money management, as it relates to constructing a successful trading plan. You can gain a better understanding of risk control, position size, stop placement, and more.

Don't Wait -- Get It Now!