Even Tiger Woods has a coach.

- Sterling Smith

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June 8, 2007

Sign up for you complimentary CD-ROM "Trading Commodity Futures". Brought to you by FuturesOne

Sign up and get your complimentary educational seminar. This interactive CD-ROM introduces you to the fundamentals of futures trading. It lays out easy to follow trading examples along with additional resources to help today's commodity trader. This comprehensive educational CD-ROM was developed by the Chicago Mercantile Exchange and brought to you by FuturesOne. To get your complimentary personal CD and learn more about this great offer go here.

Managing Risk a key to improving trading.

While it is obvious that getting the direction right is the most important factor in successful trading, the most important factor in continued successful trading is the management of the risk that is so very inherent in futures trading.

Risk management can be looked as two key elements:  what to risk on any given trade and how much risk is in the account overall.

Before taking any given trade for whatever reason one of the most important things every trader must consider this unfortunate reality:  what am I going to do if the trade goes against me. Failure to think about this possibility can be dangerous to your trading health.

There are basically to ways to help contain risk within a futures account: Stops or some type of married option. Stops are the most common way to do this and there are two ways in which I look at placing stops.

The first method is the hard dollar stop. Using this method, a trader decided on a fixed amount to risk on a given trade, usually has fixed percentage of the account. For example in a $10,000 account a trader might be willing risk 5% on a given trade, or $500.  The advantage to this technique is that it is very easy to build into a mechanical system, and always provides the trader with a very black and white answer as to where the stop is. The downside of this approach is that it does not take the market into consideration, which can lead to getting stopped when you really don’t want to be.

The second technique and the one I really prefer when using stops is a technical method that takes me out of the market when the market has actually shown that direction has changed. Major support and resistance areas are obvious areas that if they get violated it may be a sign of trouble coming. I also look at shorter term charts sometime to further fine tune this technique. This is something that needs to be handled on case to case basis and if you have questions feel free to contact me.

Remember no matter which technique you use, using some sort of technique is better than using no technique at all.

The married option is a technique that many some traders use in lieu of using stops.  Given the big markets that we have now, this technique now makes a great deal of sense. A “married” option works some thing like this. Let’s say you want to by a 30 year bond (USU7) after the big meltdown this week, looking for some sort of recovery bounce. What some traders do is the following:  Buy a USU7 futures contract which is trading at let’s say 106 12/32, and then we buy a JULY 106 put for about $500. This will provide adequate coverage to get the trade off the ground, but with only 14 days until expiration it is fairly inexpensive.

The reason I use short dated options for this is pretty simple: Most of the time, if there is trouble, it usually at the beginning. If the trade goes my way, I can always liquidate the option and place a stop.

Overall risk management is an account is just as important and selecting stops for individual trades. I have seen many a case where having to many positions on have sunk not only the battleship, but the entire navy. Believe it or not the margin requirements are actually there to help and protect you. While margin calls are no fun, all of us at some point in time do get to experience them. Very often traders exit trades which are winners in a vain effort to support losing ones. The can very often be a mistake. We should try to keep initial margin requirements to about 50 pct of account value, as a general rule of thumb.

Another important factor to consider is whether or not trades have a correlation to one of another. Very often the grains can trade together, and the energy complex very often will move together, be careful not to get overly “shot gunned” into a group of positions.

Trading is far from a perfect world and we have to know in advance what we are going to do if things don’t go the way we expect them to. Having a plan in place will help prevent making a wrong headed move out of emotion when the markets are misbehaving.

REPRODUCTION OR REBROADCAST OF ANY PORTION OF THIS INFORMATION IS STRICTLY PROHIBITED WITHOUT THE WRITTEN PERMISSION OF FUTURESONE AND STERLING J SMITH. THE INFORMATION REFLECTED HEREIN IS DERIVED FROM SOURCES BELIEVED TO BE RELIABLE; HOWEVER, THIS INFORMATION IS NOT ASSURED AS TO ITS ACCURACY OR COMPLETENESS. OPINIONS EXPRESSED ARE SUBJECT TO CHANGE WITHOUT NOTICE. THIS MATERIAL AND ANY VIEW EXPRESSED HEREIN ARE PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND SHOULD NOT BE CONSTRUED IN ANY WAY AS AN INDUCEMENT TO BUY OR SELL COMMODITY FUTURES OR OPTIONS CONTRACTS. FUTURESONE AND ITS OFFICERS, DIRECTORS, EMPLOYEES AND AFFILIATES MAY TAKE POSITIONS FOR THEIR OWN ACCOUNTS IN CONTRACTS REFERRED TO HEREIN. TRADING FUTURES INVOLVES RISK OF LOSS. DO NOT DUPLICATE.

This publication is strictly the opinion of its writer and is intended solely for informative purposes and is not to be construed, under any circumstances, by implication or otherwise, as an offer to sell or a solicitation to buy or trade in any commodities or securities herein named. Information is obtained from sources believed to be reliable, but is in no way assured. No assurance of any kind is implied or possible where projections of future conditions are attempted.

Futures and options trading involve risk. The valuation of futures and options may fluctuate, and as a result, clients may lose more than their original investment. In no event should the content of this market letter be construed as an express or an implied promise, assurance or implication by or from FuturesOne or Sterling J Smith that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance.

This week's author is Sterling Smith. FuturesOne Vice President and CTA, Sterling Smith, creator and publisher of the FuturesOne Power Index, is a veteran broker and widely quoted market analyst. Beginning in the futures industry as a risk manager for a large FCM, he moved to a major clearing firm and learned from some legendary traders. He incorporates the benefits of these insights to help every client construct better trading plans and to enhance their understanding of the marketplace.

Sign up for you complimentary CD-ROM "Trading Commodity Futures". Brought to you by FuturesOne

Sign up and get your complimentary educational seminar. This interactive CD-ROM introduces you to the fundamentals of futures trading. It lays out easy to follow trading examples along with additional resources to help today's commodity trader. This comprehensive educational CD-ROM was developed by the Chicago Mercantile Exchange and brought to you by FuturesOne. To get your complimentary personal CD and learn more about this great offer go here.