Futures trading can provide many benefits to a wide array of investors, including hedging, diversifying a portfolio, or simply taking advantage of the opportunities presented in the commodities markets. Many new traders wonder how they can limit their risk/exposure while still being able to capitalize on price movements in volatile markets. There are a variety of risk-management strategies you can pursue, including the use of contingency orders and options. First and foremost is choosing your trades, and the markets you trade, wisely.
Contingency Orders
Contingency orders are always recommended on any type of trade, regardless of the intended trade length. A contingency order is an order that is executed when certain conditions are in place. These orders include stops, limits, one-cancels-the-other (OCO), and others. A common misconception is that stops and other contingency orders take you out of the market too soon and do not allow you to ride out the movements of the market. However, if the order is placed correctly based off technical indicators, it can help ensure that if the market turns against your position, you will limit the amount you were originally willing to risk on the trade.
You can always re-enter the market if your contingency order is filled; however if you do not use one, you may not have the luxury of being able to afford to trade again. To learn the details of specific contingency orders and how they might work in specific market situations, we encourage you to give us a call. You can also read this article about the use of stops, titled, “Types of Stop Orders, a Tutorial.”
Options
Buying options is another way to hedge your risk in the market. Buying options and option debt spreads allows you to define your risk when entering into a trade. Buying a call gives you the right, but not the obligation, to enter into a long futures position. Buying a put gives you the right, but not the obligation, to enter into a short futures position. Even if the market falls to zero, you will only lose the amount that the option originally cost to you to buy, called the premium.
Options can also be used to hedge your current futures position with the use of a protective put or covered call. In a covered call, calls are sold against a long position in the underlying instrument. You are in essence limiting yourself on any potential profit, but you receive the option premium in return. Read more about options in this article, “What are Options.” You can also call in and listen to our telephone hotline, “Strictly Options,” at 312-788-2992 for more information about the markets and specific options strategies each trading day.
Have a Plan
Having a plan in place before you set out to trade is perhaps the most important part of risk-management. Carefully choose which markets are appropriate for you to trade based on your goals and account size, and how much you are willing to risk. You should always have a proper risk-to-reward ratio planned before placing any trade. As we like to say, “plan your trade and trade your plan.” The leverage that futures can provide corresponds to the margin that is required in a specific market. You never want to overextend yourself on a trade by risking more than you are comfortable with, or trading too many contracts. Leaving the proper amount of equity in your account to cover sharp changes in the market is the key to maintaining positions–and staying in the game to trade when the next opportunity comes around. If you have any questions on risk management in the futures markets, please don’t hesitate to contact us.
Phillip Streible is a Senior Market Strategist with Lind Plus, Lind-Waldock’s broker-assisted division. He can be reached at 800-803-8037 or via email at pstreible@lind-waldock.com
David Juarez is a Market Strategist with Lind Plus. He can be reached at 800-803-8037 or via email at djuarez@lind-waldock.com.
You can hear market commentary from Lind-Waldock market strategists through our weekly Lind Plus Markets on the Move webinars . These interactive, live webinars are free to attend. To sign up, visit https://www.lind-waldock.com/events/calendar.shtml . Lind-Waldock also offers other educational resources to help your learn more about futures trading, including free simulated trading. Visit www.lind-waldock.com.
Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.
Futures trading involves substantial risk of loss and is not suitable for all investors. © 2009 MF Global Ltd. All Rights Reserved. Futures Brokers, Commodity Brokers and Online Futures Trading. 141 West Jackson Boulevard, Suite 1400-A, Chicago, IL 60604.
