How Small Traders Can Participate In Gold

Gold is the epitome of a commodity market; yet it can be one of the most treacherous to participate in.  Those looking for high levels volatility need not look any further. The precious metal’s price is capable of volatile price swings that can make even the soundest of traders look foolish.   But it has also been known to churn wealth to the greenest of traders which keeps speculators intrigued. 

Many small retail traders have simply given up on the idea of speculating in the high-risk, high-margined, yellow metal at the hands of a tumultuous trading experience.    For some traders the standard sized gold futures of 100 ounces is simply too big for comfortable position trading and alternatives such as ETFs are inefficient instruments for commodity speculation due to fund rebalancing and fees.  However,  for those traders with low risk tolerance, or a preference for sound sleep, there is a way to participate in the pure speculation futures markets offer with manageable risk: e-Micro gold futures.

WHY E-MICRO GOLD?

The e-Micro eliminates many of the challenges the original gold futures pose.  For instance, the margin needed to trade a single contract of the original 100 ounce gold futures overnight is a hefty $8,800, but the 10 ounce e-Micro version of the futures contract can be traded for as little as $880.  Similarly, although a 100 ounce contract produces a profit or loss of $100 per $1 change in the price of gold, an e-Micro trader experiences an account change of only $10.  Obviously, due to the reduced contract size, this contract offers very little value to day traders. For those looking to “buy and hold,” or the opposite, for days, weeks or months; the e-Micro is a great option. 

USE SMALL CONTRACT SIZE TO YOUR ADVANTAGE: DOLLAR COST AVERAGE

Trading with less leverage creates an opportunity in which there is greater room for error.  In a perfect world, we would all buy the lows and sell the highs but anybody that trades will tell you this is nearly impossible.  As a result, even traders that correctly speculate on the direction of prices typically experience drawdowns in their trades before the market moves in the favorable direction.  Thus, it makes sense to enter a position trade with a nibbling strategy as opposed to entering the market all at once.  Such an approach is much easier to implement with e-Micro contracts than would be the case using full-sized version.

To illustrate, if a trader wants to be long 100 ounces of gold through the futures market he has the option to buy a full-sized contract at the market price, we’ll assume it is $1,350, and hope he was savvy enough to pick a good entry spot.  Alternatively, he might look to buy an e-Micro gold futures contract at the current price of $1,350, while placing an order to buy another at a $1,345, another at $1,340, and so on.  Doing so enables traders to potentially improve their average entry price and mitigates the odds of the mental anguish of a large draw-down.  Also, a lower average entry price creates a scenario in which the price of gold must appreciate less to turn a profit to the trader.

Even traders whose intent is to be long gold in smaller quantities can benefit from the comfort of the smaller contract size.  At a margin requirement of less than $1,000, a small retail trader can get long gold futures on a long-term basis with reasonable risk.  For instance, a trader that purchases the traditional 100 ounce futures contract at $1,350 with the intention of being in the trade for the long-haul would see a drawdown of $5,000 if prices retested support at $1,300, this would be enough for most retail traders to shed a tear or two…or at least lose some sleep.  Conversely, an e-Micro trader would be suffering a loss of a mere $500 and would likely be eager to add a contract to the position as a means of dollar-cost-averaging the trade.  It is easy to see how the mental state of each of these traders might be dramatically different.  In addition, I think it is fair to say that most prefer the latter.

TRADING IS A MENTAL GAME

It is no secret that opting to trading e-Micro futures over the full-sized version equates to far less profit potential.  However, I’d like to point out that most speculative traders lose money.  Thus, perhaps trading smaller size with similarly smaller profit potential directly equates to smaller risk, and arguably, higher probabilities of success. 

My assumption that this is a higher probability venture lies in the psychological aspect of the trade.  I firmly believe that the difference between making and losing money in the futures markets is largely dependent on the trader’s ability to remain calm in trying situations, and avoid the ego that comes with large profits.  Naturally, it is easier to keep your wits about you when the risk is smaller; alternatively, the higher the leverage and volatility in your account balance, the more prone to panicked and detrimental decision making you will be.  E-Micros “Buy” you Time

In most cases, it is easier to correctly speculate on the direction of future prices on an intermediate-term basis, or even long term, as opposed to what might happen in the next few hours or days.  For most traders, a full-sized contract simply doesn’t provide the ability to comfortably establish trades intended to be held for weeks or months.  After all, in early-2013 gold prices fell over $100 per ounce in a single trading session.  This translates into a profit or loss of $10,000 for the traditional 100 ounce contract, but a more manageable $1,000 loss for an e-Micro trader.

Simply put, it is much easier for a trader to commit to their research and game plan with the luxury of time and manageable profit and loss fluctuations.

CONCLUSION

I suspect that many readers of this article are thinking that the e-Micro is a waste of time.   On balance, traders likely won’t see windfall profits trading a contract that is worth a mere $10 per $1 change in gold.  Nevertheless, one should look at the opportunity in the opposite light; it might take considerable time, or a gross lack of effort, to go bust trading a single lot of the e-Micro gold. 

Keep in mind that a trader could theoretically double a $10,000 in a year with a profit of just $50 per day.  It doesn’t take a 100 ounce gold contract to meet that goal; one would likely have better odds of achieving the goal with a much smaller and comfortably sized contract.  Of course, although making $50 per day in a $10,000 trading account sounds “easy,” I assure you it is not.

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Carley Garner is the Senior Strategist for DeCarley Trading, a division of Zaner, where she also works as a broker.  She authors widely distributed e-newsletters; for your free subscription visit www.DeCarleyTrading.com.  Her books, "A Trader's First Book on Commodities," "Currency Trading in the FOREX and Futures Markets," and "Commodity Options," were published by FT Press.

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edjaworska1: RT @TraderPlanet: Trading with less leverage creates an opportunity in which there is greater room for error #gold http://t.co/8U3dBM9rBS
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carleygarner702: RT @TraderPlanet: Small account, but big ideas? Take a look at e-micro futures here http://t.co/8U3dBM9rBS via @carleygarner
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edjaworska1: How Small Traders Can Participate In Gold http://t.co/9KhRJIXvAG via @TraderPlanet
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carleygarner702: RT @TraderPlanet: How Small Traders Can Participate In Gold http://t.co/8U3dBM9rBS #MicroFutures via @carleygarner http://t.co/8U3dBM9rBS
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