Futures traders are wisely advised to trade with money they can afford to lose. That is because most beginning futures traders DO lose money. So, even if your dream is to use your life savings as capital to support your new occupation as a trader, you should curb your impatience and start with a small account while you learn the ropes. If you can make money with a small account, then by all means commit more funds later…
A better approach is to leave your life savings alone and plan your move into trading over a period of time, preferably while you have regular income from a conventional job. Again, it is a good idea to start with a small account while you learn about your new business. Your objective should be to grow the small account into a substantial nest egg which will form your trading capital when you retire or resign to become a full time trader. That way you will be trading your profits, not your life savings.
Having said that, trading a small account has a number of difficulties avoided with larger accounts. Before I discuss what these are, I need to digress for a moment.
Any experienced trader knows the importance of having a trading plan and sticking to it. “Plan your trade, and trade your plan” should be your motto. Without a plan you have no reference points during a trading session, you have no feeling of what to look for and what to do if you find it. Unless you turn out to be a freakishly talented intuitive trader, you will not be long for the trading world if you try to trade without a good plan.
The idea of the plan is to identify the setups which tell you when to trade, how large a position to take, where to place stops and targets, and when to exit the trade. Armed with the set of rules established in your plan, you are ready to set out on a voyage into the turbulent waters of the commodities markets. At least you now know how to react when the market throws different situations at you, as it invariably will.
There are some important numbers to know about any trading plan. They are the probability of a win, the probability of a loss, the average win size (dollars), and the average loss.
No setup is infallible, so inevitably some trades will lose. If you take 100 trades using a particular setup, and 60 of them win and 40 lose, the probability of a win is 60% and the probability of a loss is 40%.
If, for the same 100 trades, the average win is $200 and the average loss is $300, we have enough information to work out the likely effectiveness of the plan.
You can calculate the “Expectancy” of the plan, which is the average dollar amount you expect to make per trade before trading costs, by multiplying the average win by the probability of a win and subtracting the average loss multiplied by the probability of a loss. Unless this is a nice big positive number, your plan is no good.
In the example above, (60% x 200) – (40% x 300) = 0. In other words, over a long period this plan makes an average of nothing per trade, and will lose money because of trading costs. You would be amazed how many beginning traders use plans like this!
Most viable trading plans stress either a high win rate, or a high average win to loss ratio. Unfortunately, it is almost impossible to increase both these variables at the same time. Increasing the average win rate almost invariably forces a decline in the average win to loss ratio, and vice versa. This is the dilemma faced by all system designers.