Futures Trading Risk Management

Anytime you invest your money into something with the goal of making a profit on that investment, whether it is the stock market, the real estate market, or even the futures market, you must expect that there exists a certain level of risk involved.In futures trading, risk management is the major difference between winning and losing traders. There are lots of different trading systems and ways of looking at charts, and traders have made money from all of them. But no trader can consistently make and keep money without risk management.Risk is the variability of returns. Of course the most important risk is that of negative returns on capital - that is trading losses. Your goal is to have a smooth upward sloping equity curve, without significant peaks and troughs. The equity curve represents the total balance of your trading account over time. Losses should be small relative to your trading capital.Since the futures markets cannot be controlled or accurately predicted, risk is part of trading. Management of trading risk is the difference between winning and losing. Part of managing risk is having a viable trading system, but there is more than just this.One side of risk management is cutting lossing trades while the losses are small and manageable, while letting profits run as long as they are increasing. There are two sides of trading risk - profit and loss. If you cut both your profits and losses early, your account will suffer. Losses are a part of trading, and need to be compensated for by larger profits.I like the analogy of a bird trap. A man sets a trap, and finds 5 wild turkeys in it. Then one walks out before he can close the trap. He leaves it open, reasoning that the turkey might walk back in. Then another turkey walks out and he only has 3 left now. Eventually, the bird trap is empty. You need to both cut losses, and realise profits. When a profit declines by a certain amount, you need to realise the profit, and not let the market take it back.An effective risk management tool available to futures market traders is the stop loss order, which actually is what you need to implement for the above strategy to work effectively. A stop loss order is in effect an order to sell when the price on a contract drops to the amount specified on the stop loss order.Stop loss orders work best when they are arranged at the same time a new futures contract is established. Doing so in effect forces the trader to play out the various scenarios with a clear head and keeps the trader from making emotionally-based decisions.By determining beforehand the maximum amount the trader is willing to lose, losses are kept to a minimum. It’s been proven time and again that traders who forgo use of stop loss orders lose far more than they anticipated.Another risk management practice is to only risk a certain percentage of available capital on each trade. This is related to both setting stop losses, and also trading at an appropriate scale. Just because you have enough margin for 10 contracts doesn’t mean you should take them all on. Beginning traders typically take on too much risk relative to their capital by trading, say, 5 contracts instead of 1.If you have enough capital, you can diversify your trading across different contracts to reduce risk. You need to be careful to not take positions in different contracts that are highly correlated, even if they are different markets. This ends up being the same as taking on more contracts of the same commodity. Instead of spreading your risk over multiple markets, you end up putting all your eggs in the one basket.Risk management is vital to preserve your capital, and more importantly your peace of mind and confidence.