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While the trading methodology is important, it is the application of valid risk management principles that primarily determine the trader's success or failure. |
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Many new traders think that margin is somehow related to risk management. Margin requirements are related only to the amount that the market may move in one day. A margin-to-equity ratio of more than 1 to 5 is excessive, probably resulting in bankruptcy for that particular trader. Overtrading on equity is common among novice traders. Commodity trading involves immense leverageand the leverage can work both ways. Always remember that risk is a possibility of a loss of equity while in the pursuit of profit. |
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The majority of professional traders use no more than 50 percent of their total capital to trade with. The other 50 percent is placed in T-bills, earning a little bit of interest. This provides a cushion, or reserve, during draw-downs and losing streaks. In other words, if the total amount of funds deposited with a clearing firm is $100,000, then $50,000 is used to trade with and $50,000 is placed into Treasury bills. |
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Professional traders monitor the amount at risk as determined by where their exit strategy and stop placement are. Generally no more than 4 percent, and typically 1 to 3 percent, of the total equity is placed at risk on any one trade. So, for example, if there is only $100,000 in the trading account, the trader will place at risk no more than $1000 to $4000. In other words, the trader is willing to lose (risk) no more than 1 to 4 percent on any one particular trade. This naturally limits the number and type of contracts traded, and is accordingly an important consideration. |
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The trader will also limit the amount of margin deposited for any one market to no more than 25 percent of the total equity. Of the capital that is available to be used for trading, 10 percent will generally be available for margin deposit for any one diversified market. In actuality the amount of total margin in any one market group will vary from 10 to 25 percent. Professional traders will diversify the markets that they trade. This is in order to prevent financial ruin by placing all their trades into one correlated market group. They will also diversify by using different methodologies that they have developed. |
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Allocation by Diversification |
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For example, if you are trading Treasury bonds and Swiss francs with $100,000 in your account, then staying within |
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