Specially for Beginners

Few activities have been so exhaustively studied from so many angles by so many people as the futures markets.  The rewards can be impressive for those who put forth the time and effort to understand how the markets really work; yet, the penalties imposed on those who lack the proper knowledge and/or discipline needed to trade are severe.

So why do 80-90% of all new commodity traders, especially those with modest accounts bust out and lose all or most of their investment within the first year?  In my opinion, two of the biggest reasons for this small  success rate are:

• Most new traders buy into vague systems hyped up with unrealistic promises of  what I now call The Little Work/Big Gain Theory.  This is not a "get rich quick" game that can be treated lightly.  Nor is it something that can be jumped into without study and some basic knowledge of the markets and trading psychology.  To succeed one must treat this as a business with specific goals and objectives.  One must also have and follow a system with solid ground rules.  Whatever system you choose, it should have a consistent method for selecting the right markets to trade and controlling risk exposure. 

• Just as all successful businesses must control their risks, so must you.  Lack of  good risk management is one of the main reasons many new traders bust out during their first year of trading.  Basically, winning or loosing all boils down to how a trader handles his or her losses.  All accounts have limited amounts to  invest.  Those with larger more well-funded accounts can afford to trade more contracts and/or higher risk markets but even they must adhere to strict risk rules.  Proper risk management allows one to make the most of what is in one's account at the moment.  In other words, proper risk management will keep you in business and allow you to trade again tomorrow, next week, and next year.

So what if you don't have $20,000 or more, but still want to open an account?  First of all, you must realize that you cannot afford to trade the high risk markets with a small account.  Nor are you going to be able to establish numerous positions in different markets.  Even the smallest futures contracts can require anywhere from $500-1500.00 in margin money per contract.  This in itself limits those with $5,000.00-10,000.00 accounts to trading only one or two markets at a time.  But there are other exchanges such as the MidAm that trades much smaller futures contracts.  Typically, the Mid-America or MidAm Exchange trades most of the major commodity and currency markets.  These contracts are usually 1/5 to 1/2 the normal, full sized contracts which means less risk and smaller margin requirements.  Of course, the returns are half the size of that on the full sized contracts but the object here is to build your account up to the point where you can trade full sized contracts.

Each futures contract has a set amount and/or grade of the particular commodity in question. For example, if you buy a single Lean Hog contract, you are ‘holding’ the equivalent of 40,000lbs of lean hogs. Whereas, if you sell a single wheat contract you are selling the equivalent of 5000 bushels of wheat.  A MidAm Lean Hog contract would control 20,000lbs of lean hogs whereas a MidAm Wheat contract would control 1000 bushels of wheat.  The "tics" or point moves in the MidAms are adjusted accordingly.  For example, in a MidAm Lean Hog contract, one point would be worth $2, whereas a 1-cent move in the MidAm Wheat contract would be worth $10.  (Since the margin requirement for a full sized Wheat contract is usually less than $1000 you might want to consider using full sized contracts when establishing a position in this particular market.)

As you can see, each tic or point move in a particular contract is worth a specific amount and can vary between contracts.  Obviously, this makes some contracts worth more than others.  Using the above example a 1-cent move on a lean Hog Mid-am contract is worth $2, so a move in the market from $60.00 to $61.50 would be worth $300 per contract if you were long.  (61.50 - 60.00 = 1.50 x 200 = 300.00)  In wheat, a 1-cent move is worth $10.00, so a jump in price from $265 to $270 would be worth $50.  In this particular case, the trader going long or buying these two contracts would have made $350.  If this trader had shorted or "sold" these two contracts he/she would have lost $350.  To learn more about figuring profit and lost go to Lynne's Lesson #1