Futures Trading Rules

Here are some simple futures trading rules, which come from our experience, and that of successful traders.

Don’t overtrade

Overtrading is when you trade more positions than are justified by the amount of margin in your account. For example, if you have $10,000 in your account, this does not mean that you should trade 10 positions. In fact, you should probably trade 1 or 2 positions.

Overtrading reduces your ability to absorb losses and continue trading. Losses are a fact of life for all traders, so plan accordingly. You should trade about 1/5 of the maximum number of positions that you can open.

If you don’t have the capital to cover a full sized contract, consider the mini-contracts offered on some exchanges.

Take a medium to long term view

The shorter the trading timeframe you take, the more of your profits will be taken in trading expenses. In addition, it is more difficult to trade short term positions because trends may change very quickly, and you will need to watch the market constantly.

If you take a medium to long term view, you can benefit from trends that are relatively easy to identify. You will need to tolerate larger adverse movements, but can also take larger profits. The amount of time required is far less.

Never add to a losing position

If you have a losing position, you should have an exit plan which includes a stop loss. Don’t make your position worse by adding to a losing position. This simply magnifies your losses, should the adverse movement continue. If you have made a mistake, then close out the position and put it behind you.

Don’t trade against the trend

It is a mistake to try to pick market tops or bottoms (reversal points). Wait for the market to clearly indicate a trend rather than trying to pick the change in trend, and ending up trading against the prevailing market trend. Trading against a trend is a sure way to lose money.

Develop your own trading system

Every successful trader uses a system. A good trading system will result in average profits greater than average losses, with a manageable level of risk (measured by drawdown, or the maximum adverse impact on your account).  A system needs to tell you when to enter the market, how much risk you need to take in a position (which will determine your stop loss) and when to exit (it is unlikely that your system will be able to tell you what the exit point should be at the time when you enter a position).

Develop your own trading system so that you can be confident of its effectiveness, and not be tempted to second guess it. We recommend against buying someone else’s system.

Don’t trade fast markets

A fast market is where some important news has been released, and the market moves very quickly in response. This is not a good time to trade because you can’t be sure of prices really are, as reporting will tend to lag - you’ll get bad fills which may be compounded by a sudden reversal in direction.

If you take a longer term perspective, you won’t need to be unduly concerned with very short term fluctuations in the market, so there will be no need to attempt to trade on releases of market information

Always use a stop loss

You should always use a stop loss to prevent huge unforeseen market movements from wiping out your account. Your trading system should help you quantify the maximum adverse movement you can incur before being wrong. You should place your stop loss when you open your position.

Let profits run

It is always tempting to take a quick profit, but successful traders cut losses short, and let profits run. Your system should give you a clear signal when to take a profit. If you take small profits, it is unlikely that you will make enough to cover the inevitable losses.

Manage your risk

Managing risk is all about understanding and limiting the potential impact of sudden market movements. One way of limiting risk is using stop losses, which is discussed above.

As well as not overtrading, you also need to be aware of the total risk in your trading portfolio. Some commodities tend to move in the same direction (that is, they are highly correlated). For example, grains will tend to be correlated.  If you have several positions in correlated currencies, they could be acting like a single larger position which increases your risk.

Conclusion

Following these basic rules will help you survive and prosper in the fast moving futures markets.