Thursday, August 05, 2010

Emini Futures Trading / Size Matters


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Michael X

I understand the politically and socially correct question here is actually "Does size matter?" I'm not asking a question, I'm making a statement. It matters. A lot. So get your mind out of the gutter we're talking about trading here. 

Interestingly enough, the answer you've always heard to that real life question also applies to trading. There is a place however, where the paths diverge, it's called Wall Street. Whatever Mother Nature hands you, that's it. I don't care what the ad in the back of the comic book says, it's a lie. Here's where trading differs, if you learn how to properly handle what you start out with, properly handle your position size, over time, your account size will grow. As your account size grows, your position size grows, and as your position size grows, your account size ....... you get the picture right? And trust me, if you get that side of the equation correct, the fact that you somehow feel short changed in other areas of life suddenly becomes a much easier thing to deal with.

Tomorrow we have a very special guest. A man who trades in sizes that most of us haven't even dreamed of yet. Now we all know that traders can dream. We've all got big plans. Right? I've often thought of trading 100 contracts. Even if just to see what it felt like. I may have even fantasized about swinging 1,000 after an especially good run. But never in my wildest imagination did I consider trading 9,000 contracts in a day. Our guest tomorrow is just such a man. He was a guest on our radio program a few years back and while we considered him to be a "large" trader even then, by carefully managing his account and position size, he is now a "huge" trader and we are honored to have him back on the show.

Don't worry, you won't have to sit through any phony tales from the pit, or listen to any chest thumping braggadocio. Michael is a rather quiet and private individual despite being one of the single largest Emini traders in the market today. What you'll hear is real. Tomorrow is non-farm payroll day and Michael is quite keen on trading news driven events. It will most probably be towards the end of the program but it could be earlier so tune in for the full 2 hours.

Why Size Matters
If you open an account with $5,000.00 or $50,000.00 the same logic applies. Let's run the numbers on the $5k account. The average intra-day margin for 1 Emini contract is $500.00. In theory your very first trade could be for 10 contracts. 10 X $500 = $5,000.00. If the trade moves 1 tick in the wrong direction you're now receiving a call from your broker and being introduced to a margin call. That's if he's your friend. Many firms will simply begin liquidating the position. So there's a quick lesson on how Not to Trade. Let's apply some simple logic and see if we can obtain better results.

A very old and highly regarded investment rule of thumb is to never risk more than 2% of your capital on any 1 trade. The truly conservative guys say 1%.  If we have a $5,000.00 account 2% = $100.00. We have a problem here.  Remember, it takes $500 margin on average to trade 1 S&P 500 Emini contract (which by the way means you are controlling the equivalent of $50,000.00 of S&P stocks if the S&P is trading at 1,000.00).

With a $5k account to trade just 1 Emini contract means we need to risk 10% of our account balance correct? Not exactly. The point value of the S&P 500 Emini is $50.00 per point. If you allow a trade to move against you by 10 points you have indeed imperiled 10% of your account. However, if we use a reasonable stop loss order of 2-3 points, we are only risking at most $150.00 of our $5,000.00 account. In other words, we are only risking 2-3% of our total account size on any 1 trade. If in fact the trade does go our way, the market will pay us the same $50.00 per point. Once you have a net gain of 10 points after commissions (10 X $50.00 per point = $500.00) you have "earned" the right to trade 2 contracts. If the market moves against you the maximum loss using our reasonable stop scenario now becomes $300.00. hmmm.... that's 5.5% of our total account size. What's a trader to do?

What you must do is implement a money management plan. You must decide based on the numbers, which path you should take. The primary goal should be to protect the initial stake of $5,000.00. This is not to say you should trade loose with the "house's money" because there is no such thing. That is money you earned by successfully putting on and taking off trades. I will not clutter the air here with "how much you can make". You've already put pen to paper and figured that out. Take that piece of paper, crumble it up and toss it away. Focus solely on preserving your initial stake until such time that your account size is increased to a point where you are now able to focus on protecting a larger portion. The rest will take care of itself unless your size and success leads to hubris (the ancient Greek concept of arrogance and overconfidence) at which point you will be required to repeat the process again and again until you get it right.

Listen, God! Please, pay attention! Can you make sense of these ramblings, my groans and cries? King-God, I need your help.
   Every morning
      you'll hear me at it again.
   Every morning
      I lay out the pieces of my life
      on your altar
      and watch for fire to descend. 
Psalm 5 1-3 The Message

Weekly Trading Zones
We will update the charts tomorrow night. Hopefully something will have happened by then. Watch 1135/1136 as a possible resistance area if the news is good.

Pray Hard & Trade Safe!

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