Understanding Risk

Before I talk about my system and how it will make you money , let me first discuss the "Warning" that you just read above. The thought of losing a lot of money scares many people.


Overcome Your Fear

Let me ask you a simple question that I would like you to honestly answer. When you drive your car to work tomorrow is it possible for you to be killed in an automobile accident? Yes, it is possible but highly unlikely. Why? Because you will drive within the speed limit, you will obey the traffic laws and you are an experienced and careful driver. This is a reasonable risk that you take each day because the odds are low that you will be killed. But it could happen, right?

Read the warning above again. It reads, "one could lose the full balance of their account". Being careless and trading too many contracts is like driving 50 mph over the speed limit. Or if your trade goes through a stop sign (pun intended) it is like disobeying the traffic laws. Irresponsible trading, like driving reckless, can lead to serious consequences.

You will learn about a money management system on this web site. It will keep from risking too much money on a single trade. You will stay well within your trading limits, like driving under the speed limit, your trading will not be reckless or out of control.

Managing your fear is knowing how to trade responsibly.


Size Of Risk Lowers Fear

Understanding your fear has everything to do with the size of risk. When you were a child did you ever buy a package of flower seeds? The cost was approximately $1.87 for 100 seeds (in today’s dollars). If you were like me, the chances of getting any flowers to grow were slim to next to none. I remember not getting one flower from a whole pack of seeds that I bought. I lost 100% of my money. I use this illustration because farmers, too, have a risk when they plant their corn crop for the year. They do not know if any corn will grow. As traders, we assume the farmer's risk of not knowing if he will get a crop.

A package of flower seeds is small. It never really bothered me to lose my $1.87. However, having a whole field of corn not grow is a different story. And if you put the loss of that corn field into two trading days, it has even a greater impact on your peace of mind. What I mean by that is a farmer loses his crop over the period of a growing season; i.e. a drought slowly burns his crop. You, on the other hand, are short corn and the USDA crop report comes out and corn limits up for two days in a row before you can get out. Now who is "burning"?


Leveraging Is The Key.

I meet people who will trade stocks, but not trade futures. They could buy stocks on 50% margin, but most people pay the full value for their stocks. This is how many people think when it comes to investing. They pay current market price and put up all the money. However, when you buy a futures contract it is the norm to buy on margin as low as 4% of the contract value. This is why trading futures has the reputation of being "risky". Your money can grow or dwindle at a very quick pace. To make trading futures like buying stocks, where you don’t lose your money so fast, just buy each contract with the full contract value in your account.

Let me explain this concept with a corn position. The current margin requirement for corn is $472. December corn is trading around $2.10. A contract is 5000 bushels, so the value of a contract is 5000 x $2.10, or $10,500. If you commit $10,500 to purchasing a corn contract and the corn moves 2 cents in one day, your percent of change is less than 1% for that day. That is a similar move for a stock position. If I think of this trade in relation to a $472 margin requirement, now my daily move is over 21%.

If I told a friend, "I bought corn futures last summer and made $4,000 on a summer rally." he might ask the inevitable uninformed question, "How much did you invest to make $4000?" It is difficult to answer that question without confusion because I do not think in terms of how much money in my futures account is actually committed to that corn position. Sure, I know my stop, which may be a $500 stop loss. Or the margin might still be $472 if I was long before the summer rally began. So how much did I use to invest? How large is my trading account? It is all a matter of how you view your funds. Is my $5,000 account today only a portion of the $100,000 I am going to have to trade futures over the life of my trading career? Do you understand my point? Is losing $5,000 ALL your money or only 5%? The way you view your current trading funds can also change your level of fear.

This is a true story. I once made a trade with no money in my account. My broker was a personal friend who trusted me. She was working at a commercial clearinghouse that only cleared for hedging accounts. My account was there because she was my broker at a previous clearinghouse when she moved. The new place did not have margin requirements on spreads. I put a hog spread on and had a small profit by the close of the day. I never did "invest any money". What was my risk? Better yet, what was my return on my money? Who knows. My point is I knew what that spread would do and didn’t have a fear that "it is also possible to lose more than the initial deposit when trading futures", which was $0. I made about $600 on that spread and to this day I still don’t know what my return was on my money.