Weekly Insights: A Realistic Look at Futures Trading

A Realistic Look at Futures Trading


A futures trader’s mission is to be profitable by taking the preponderance of technical and/or fundamental evidence he or she has on a market and then making a well-founded trading decision based on a trading plan of action. That is the best a trader can do. If the market does not respond in the way the trader thought it would, he or she will hopefully have a tight protective stop in place to keep losses to a minimum. Then, the trader moves on to the next preponderance of evidence on a market, and the process starts over.

Veterans of the business know there is no “Holy Grail” for futures trading success. We know how brutal the markets can be to even the savviest and deep-pocketed traders. The principals at the big hedge fund Long-Term Capital Management certainly know what I am talking about. This speculative trading firm, which supposedly had trading geniuses at the helm, went bust after the markets they were trading made a devastating turn against them. Some well-known investors got burned.

Yet, there are individuals, myself included, who are fascinated by the markets and trading, and find great satisfaction when we can “take some money off the table.” We know there are dangers to futures trading, but sound and strict money-management principles can greatly reduce the dangers of losing all of one’s trading assets. After all, one of the realities of futures trading is that trade-offs exist in just about every trading method or trading philosophy. In fact, there are advantages and disadvantages to just about everything we do in life, so why should futures trading be any different?

Here are the trade-offs for just a few futures trading methods. These trade-offs may be obvious to some, but I believe it is prudent for all traders to have a very clear picture and a keen understanding of what they are up against when they initiate a trade and take on “the market,” which can quickly turn into a two-headed monster if it is not respected and understood.

Purchasing options on futures: This is a great way for individuals, especially beginners, to participate in futures market trading and limit their risk to the price paid for the option. Traders sleep well at night, knowing that if the market makes a violent turn against them, they will not get a margin call from their broker. The trade-off: For the traders that purchase options, the timing of the trade must be even more precise than straight futures trading, as options expire well before the underlying futures contract and “time decay” continually erodes the option premium. Also, in volatile markets, options premiums increase significantly. Finally, if an option that is purchased is not “in the money,” any favorable moves in the underlying futures contract price will likely not be matched on a one-to-one price basis by gains in the option’s value.

Selling options on futures: There is an old market adage that says most of the profits made in options trading are made by the sellers and not the buyers. I do not disagree with this. The trade-off: There is another adage that says options sellers will make good profits–until that one time a market turns unexpectedly and violently against them and wipes out all the profits they had previously made writing (selling) options.

Trading volatile markets: Big profits can indeed be made trading volatile markets. In the past couple of years, the energy futures markets have been one example. The trade-off: Volatile markets can turn against a trader on a dime. Big profits can turn into big losses in very little time. I call a highly volatile market a “gunslinger’s market.”

Using tight protective stops: I use protective stops with nearly every trade. It is a good way to go into a trade with a plan of action, should the market turn against you. For traders who do not have real-time price data or who cannot monitor price action all session long, stops are an excellent risk-management tool. However, protective stops are not perfect. They are not effective in “fast” market trading in the pits that see a price vacuum. Stops are virtually useless when a market makes a limit move. Floor traders will sometimes “gun” for resting stops, trigger them, and then the market seems to reverse.

System trading: I do not use a mechanical system for trading, but many traders do successfully. By “system trading,” I mean using computer-generated buy and sell signals, which are based on certain parameters fed into a computer trading program. Some of these trading systems are advertised as being 90% profitable. The trade-off: Many system trading advertisers do not tell people that with most computer-generated trading systems, a trader is in the market–either long or short–virtually all the time. Drawdowns on the trading account can be, and many times are, very large. Also, some of the claims of high-profit percentages are based on a trading system that is hypothetically back-tested over several years.

Again, there’s no magic formula for successfully trading futures, but taking a little time to understand the trade-offs for the particular type of trading method you are using is time well spent.


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