Advanced Risk Management for Futures Traders

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Contributor, Benzinga
January 24, 2023

Though they may appear random, price movements in futures trading markets often follow patterns. Traders who understand technical market movements can often predict the size and direction of futures prices. Futures trading is risky, and uncontrolled losses, amplified by leverage, have ruined many futures traders. 

A risk management plan can help you mitigate risk and maximize profits. The plan should match your risk preferences and align with how much you can afford to lose on a futures contract.  

Risk Management for Futures Traders

Traders can use several ways to reduce risk in futures trading. 

Work to a Plan

Futures trading is risky, and changes happen quickly. Don’t put yourself in a position where you get caught off guard. Nail down targets before you set up your first trade to avoid emotional decisions. Your strategy should include profit goals and an exit plan. Risk controls like stop-loss or bracket orders can prevent losses beyond what you can afford. Bracket orders include a stop loss and profit target so that you can automatically manage both and remove the human element.

Consider using One Triggers Other Orders to protect your investments. These orders activate a protective stop when you raise the initial order. Monitor and keep detailed records of your transactions. Self-monitored performance can help you to decide when to adjust your plan to make the best of market conditions.  

Start Small and Size Your Trades

If you’re new to trading, it’s best to start small. Buy one or two contracts with a portion of your available investment funds and learn the ropes. Futures trading is risky, and you’ll inevitably lose some money. Don’t make the mistake of sinking all your funds into your first contracts. Do your research and learn what you can about futures trading. Find out what works for you and adjust your plan before you put more money at risk. 

Control Losses

A stop loss is an invaluable tool, allowing you to limit the amount of money you can lose on a single trade. The stop loss level is no arbitrary figure. Carefully consider the limits that you set using technical analysis. Stop loss levels must suit the market. If you fix a stop loss that is too conservative, you could miss opportunities. Alternatively, you could take on unnecessary risk with a stop loss with more tolerance than the market needs. Find the market that suits the losses you can tolerate rather than making subjective stop-loss decisions for the best outcomes.  

 Focus on a Few Futures Contracts

Futures trading isn’t easy. Futures traders must watch the markets, read the charts and stay informed. Trying to trade in too many areas at once could result in sub-optimal results. Instead, focus on a few well-chosen futures trades. Trading on a single futures contract is also not the best strategy. Diversification is your best protection against loss. Buy several contracts so that profits on one trade can offset losses on another. Statistical arbitrage can help to identify price discrepancies between closely related assets. The goal is to profit from these discrepancies while limiting risk through diversification.

Heed Margin Calls

Margin calls are activated when your funds fall below the maintenance margin. A margin call is often a good indicator that you stuck to a losing run for too long. You will have to replenish the account. Take heed and consider abandoning your losing position or you may soon face another margin call. 

Exercise Patience 

Though you should keep a continual watch on market activity, don’t give in to the temptation of acting every time the market moves in an unexpected direction. Avoid the need to take early profits and don’t allow losses to grow beyond pre-set limits. You have logically set your strategy, so your actions should follow and support the plan. Still, even the best scheme needs occasional adjustment. Stay abreast of market changes and tweak your plan as necessary. 

What Does Risk Management Accomplish?

A sensible risk management plan will benefit you in several ways.

Minimize losses: Futures trading is risky, and you will incur losses along the way. A risk management strategy will help you to control these losses.

Maximize profits: When you have a plan, you are less likely to make emotional, spur-of-the-moment decisions. You won’t hang onto loss-making contracts nor will you be tempted to keep riding an upward trend when the time comes to sell. A plan with checks and balances will result in the most profitable outcomes.

Remove emotion: Emotional decisions have no place in futures trading. A good risk management plan includes goals and exit plans, removing the need to make quick decisions on the fly.

Why Are Futures So Risky?

Futures trading is inherently risky for several reasons.

Leverage: Futures traders put up a fraction of the investment needed to trade. The rest, up to 95%, is covered by borrowed money or leverage. Leverage raises the profit you can make but also amplifies the loss. 

Based on price movements in the underlying assets: Prices can fluctuate significantly over the contract period.

Unlimited liability: If prices move contrary to your predictions, you will continue to lose money and may have to replenish your margin at the end of the trading day. 

Compare Futures Brokers

If you’re considering your investment options, Benzinga insights and reviews can help you make the best choices to suit your risk tolerance, market knowledge and long-term financial objectives. You’ll find all the information you need, including futures trading news, guidelines, software and brokers. 

Frequently Asked Questions

Q

How do futures mitigate risk?

A

Future investors buy futures contracts to mitigate the risk of price movements in the underlying assets. For example, a farmer may sell a futures contract for crops at a fixed price to protect against a potential fall in crop prices. Futures also allow investors to diversify investment portfolios, reducing risk.

Q

What is the best strategy for futures trading?

A

No best, single strategy guarantees your success in futures trading. Your chosen strategy should suit your financial goals, market knowledge and risk tolerance.

Q

How often should you hedge against risk?

A

All investments should be hedged against risk, and you should use sound risk management planning to protect your overall portfolio.