Margins and Risk and Research, Oh My!

The following observations are based on my experience as a futures broker for the last several years.  One thing we have touched on in the past is how our customers decide to change their focus from one product to the next, and the process by which they educate themselves on products they are looking to expand into. I would like to highlight an example of how traders often misinterpret the risks associated with one product versus the next.

You’ve probably been here yourself. The stock market volatility has died. Trade volumes are low. The daily range on the Dow is 70 points. The daily range on the S&P is 9 points. “How can I trade this market?” you ask yourself.

The next logical step is to look for other markets whose volatility and ranges might not be correlated to the stock market. One common market we find our traders seeking more information on, are the grain products, such as Corn, Wheat, and Soybeans.

With a little research, one can find that the margin on Wheat contract is only a paltry $3038: (See the image below)

 “Wow! This is cheap!” you say. “It’s even less that the overnight margin on the E-mini Dow futures!” (See the image below)

 “This must mean that the marketplace, CME Group in particular, considers the risk associated with a Wheat futures contract to be less than the risk associated with an E-mini Dow futures contract! I’m going to start trading Wheat tomorrow without considering the potential risks of trading a deliverable (as opposed to cash settled) agricultural futures contract with a relatively high propensity to move into a lock limit up or down situation without doing the proper research, because I saw it in a video online yesterday!”

This attitude is a big mistake. The person above did arguably less than half of their due diligence. They did go to the CME group Website and specifically researched Performance Bonds/Margins. But while the margins you see on the exchange websites will tell you something about the perceived risk associated with one contract versus another (Silver, for example, is an extremely volatile and thin market with a margin over almost $19,000 at the time of this article), these margin requirements are only numerical values, so they alone cannot disclose to you the risk associated with their corresponding product. As a self directed trader responsible for your own trading decisions and risk, you must uncover this information yourself.

Questions to research about new markets before you proceed to trade them?

1.   What are the overnight margins? (even if you never plan to hold a position overnight, you should know this)

2.   What are the electronic trading hours and basic contract specs (tick values, open outcry hours, etc.)? (Crude Oil Example) When should I be out of my positions to avoid  a margin call?

3.   If trading Ag products, what are the daily price limits? Other (but not all) CME products have price limits as well, you can find them on the Quote Page for each CME Product, here is an example for Crude Oil (see the second column from the right)

4.   Have I read publications, commentary, and researched which economic data impacts this product the most? (Here is an example of the Crude Oil Education Page on the CME website; it’s easy to get to other products from that page.)

One could make that argument that there are countless other questions one should ask before getting involved with a new market. These are the most important, in my opinion. And the beauty of it is that the vast majority of the answers are publically available on the CME, ICE, and EUREX websites. Sadly, most self directed traders do not do this type of due diligence before getting involved with new and strange markets. The combination of unexpected economic data, thin markets, and extreme market volatility can hurt even the most prepared traders. Don’t put yourself at unnecessary risk by trading products that you have not properly researched.

- Patrick Z

Making Money in my Demo but not in My Live Account

The title of this post sums up a lot of my phone conversations with my clients.  Whether they are newbies or have been trading for awhile, traders still ask me "Why do I always make money in my demo account but when I go into my live account, I don't make money?"

There are a few obvious reasons that jump out at me when a conversation starts moving in this direction.

1.  Psychology

2.  Not Following The Trading Plan (Have no Trading Plan)

3.  Not Using Stops, Not Using Proper Trade Size

I would say the biggest hurdle of moving from a practice trading environment to actual live trading is your Psychology is affected.  This is brought on as soon as you enter your first trade and sometimes every trade thereafter.  When "real" money is on the line, you may begin to over think the trade or start to doubt the trading plan that you worked hard on while practicing.  Even worse, not having a trading plan in place before trading live. 

It's unfortunate to see many traders who don't start with a trading plan until they have lost their initial investment.  This is when I get the call and we begin talking about trading plans and I would guesstimate that about 50% or more of these traders have not made a plan or even thought it was necessary.  YES, not only is a Trading Plan essential, so is having a Trading Journal.  The more information you can collect from your own trading, the faster you can point out common mistakes and flaws in your plan and make adjustments.  Trading plans should be a work in progress. As much as you are getting experience while live trading and learning new methods that you are incorporating into your style, if the market starts to trade in a different manner than when you first started going live, you have to be able to adjust and most important, you have to be REAL with yourself - the ego must be put aside and it's time to be humbled about your trading.  This will help you SEE where you are making mistakes so that you can learn from them and do your best to avoid them in the future.

Another point to make that comes from these conversations, is when traders tell me how much they were up on their demo each day, talking 100k plus day in and day out.  Then when I ask how much they are funding their account with, I get the $5-10k comment back.  I immediately ask them how many contracts were you trading on the demo - oh about 100 to 500 at times.  Did you use stops?  No.

Well of course you are making money, especially when you don't use stops and if you take $1,000,000 in heat to make $25,000 at a crack.  It doesn't make any sense to not practice how you are going to trade.  Take advantage of your practice account, get your rhythm in the market with your trading plan and when you go live, don't be afraid to implement.  It's kind of silly to spend all that time on the demo and then not do what you wanted to do in your live account. 

On a final note, I don't believe that your results in your practice account are indicative of your live trading results (good or bad).  The reasons above are just a small sample that I commonly come across in my conversations with traders.  Be smart, be honest, use proper trade size and money management and believe in yourself.  If it doesn't work, don't be afraid to tweak your plan and do some more practice - it will help you get the functionality down so that you don't make clicking mistakes when you are trading live.  


- Josh H

Turning the Corner and Getting Paid, Part II

Been a pretty lackluster 5 months since we last wrote, right folks? With overall trading volume and volatility way down, we admit – we have not been inspired or excited to write as much. However, the customer who was the focus of Josh’s last blog is still at it, and we wanted to update you as to his progress; many of you have asked how he has been doing recently. Please note, that these statements are not indicative of all our customers, but they tell an interesting story.

Here is a snapshot of December 2012 - a modest month, but still positive: CLICK THE IMAGES TO SEE THE WHOLE PICTURE

January – another modest month, but still: POSITIVE.

February, still positive, again a modest PNL:

March:

And lastly, for now, April:

What are we trying to say here? It’s clear this person is not going to be supporting himself and his family 100% on this kind of income. But it is nice to see someone who is keeping their wits about them through a period where a lot of people are trying to squeeze blood out of a turnip (a term we've used many times on this very blog – something we see very often). Naturally, these results are not indicative of any future results and there are no guarantees when you trade futures. You should be absolutely sure that you are trading futures with risk capital ONLY. I define this as money that can afford to be lost; money that if lost, will not change your lifestyle or lengthen your retirement horizon. If you are not sure what we mean, please call us to discuss.


-Patrick Z

Turning the Corner and Getting Paid

So Patrick and I have promised you some positive, encouraging updates and stories…..so here is a story of a client that boldly sticks out to us and we are very proud of this client (and his wife) for their perseverance, patience, discipline and overall view/scope of the futures markets.

This account, prior to what you are about to see, had many downs at first, some ups but more downs. They have been through different educators, followed a number of systems and even fell into the “I win 90%+ of my trades but still lose money” category for awhile. However, through it all they have gained education but just as important – experience. It’s from their experience and many hours of “screen time” that has allowed them to view the markets in a different way than before and too help develop a method and plan to their trading.

See….becoming successful at trading doesn’t happen overnight, and if you are one of the few that do see immediate success, be smart about it as it doesn’t always work in your favor. Trading is about being able to adapt and trade (or don’t trade) in many environments.

As you continue to read this blog, you will see and read how our client is in now - “Turning the Corner and Getting Paid”.

Below you will see a clip from my client’s February 2011 monthly statement. Notice the line in the middle of the month; I drew this line as it was right around this point where my client and I had another long discussion about what he was doing wrong and why he could not find any consistency. Looking back on this monthly statement, you can clearly see his losing days were much higher than his winning days.



It was around the middle of the month, when I received another call from him stating that he was taking a new approach, an even more conservative approach to his trading. An approach that he himself knew would be tough accomplish, as he had always fallen back into bad trading habits and his discipline had been thrown out of the window time after time. This time though, he seemed a bit more confident about this “new style”. It sounded promising and I wished him the best of luck and told him to be patient and stay disciplined.

Below, in successive order, will see a clip from my client’s March, April and May monthly statements. Notice the growing balance each month but more importantly, notice his % gains. They aren’t 50%, they aren’t 30% - they are low….but steady.

March 2011 – Net Profit was 6.99% (Even he said this was a bit higher than expected)



April 2011 – Net Profit was 4.69% (It was during this month, he called and told me that his goal is to be above $100,000 in the account by Winter, maybe even sooner if he was lucky.)



May 2011 – Net Profit was 6.67%



June 2011 – Net Profit was 6.15% (I really wanted too call him and tell him how Patrick and I both were watching and rooting for him to reach his goal but we held back – we didn’t want to be a jinx!)



July 2011 – Net Profit was 2.96% (Another good month and of course, the goal of $100,000 had been met! He had given me a call once he reached his goal, which was actually more around the middle of the month but it wasn’t too gloat or too celebrate – ok, maybe a little – it was too start a new phase in his trading method/plan. Phase two of his method actually came from an idea we had on a blog about paying yourself for the hard work and hours you spend trading. Positive reinforcement for hard work goes a long way. He requested that I send him a check out of the account on the 1st day of each month but only if the balance was above $100,000. The check was to be for the exact amount in excess of $100,000 at the end of each month. I liked this idea, I liked it a lot.)



August 2011 – Net Profit was 8.15% (Please note the date of 8/1/2011, where we sent him his first withdrawal, as his balance at the end of July was $1,600.58 over the $100k mark)



September 2011 – Net Profit was 7.94% (Please note the date of 9/1/2011, where we sent him his second withdrawal from the account, per his prior request.)



October 2011 – Net Profit .84% (Please note, another withdrawal for the profits made in September).



November 2011 – Net Profit was 3.17% (Again, another withdrawal for profits made in October)



December 1st Daily Statement – This is to show the most recent withdrawal from the account.



Obviously these results are not indicative of any futures results and there are no guarantees when you trade futures. With that said though, I do look at this account and because I personally know the ups and downs that they have endured, I am proud of them. I am also confident that this account holder is looking at the longer term and at the bigger picture; which is hard for many day traders.

As you will hear me say again and again…..trading is a marathon, not a sprint. So pace yourself and be prepared, patient and disciplined. The markets will be here tomorrow, the day after, and the day after that….so, keep that in mind when you are learning and developing your trading plan.

Talk soon,

Josh

Negative Stuff. Positive Stuff.

I was perusing the existing posts recently and I just wanted to throw it out there, that our intention to create outlet is not to just talk about negative stuff and losing all the time. Our primary purpose as brokers is really to help people avoid costly mistakes so that they are around for a long, long time. That’s why a lot of the posts on this blog seem like lectures. This really is not by design. We have had some intense, heartfelt discussions with many clients over the years about their strengths and weaknesses and there just seems to be some common threads that tie those together who are even moderately consistent. These commons threads often involved things that people don’t do. Hence often find ourselves (over the phone, over email, and on this blog) saying “Stop that!”

In general, we find that the people are who do things described on this blog the least (over leveraging, not understanding the market they are trading, setting unrealistic goals, and so forth) are with us longer. And this is good for us as well.

I have been following some successful traders for awhile, and we’ll have some good highlights to show soon. =)

Realistic Goals

One conversation I frequently have with live clients is about setting realistic goals in terms of positive account growth. What is appropriate? What is necessary to make it worth the risk for the trader? Of course the answers to these questions are not all black and white. Hopefully this article helps you reflect a little bit on your daily goals.

We find that how one decides what their daily goals should look like is often driven by the following:

1) What their goals are for the account (Curing boredom? Making a living? Supplementing another income stream? The thrill?)

AND/OR

2) What have they been taught by the educating group that they have learned from?

Who wants to sit in front of a desk for eight hours per day for $50 in average PNL? Rarely do I speak with someone who is excited by that idea. However, I find often that the displeasure associated with the above (as well as other factors I have noticed) play into determining what PNL goal someone has on an average day, rather than what is reasonably possible. For example – if you have $10,000 to risk for a futures account, and you are looking to average even a $50 PNL per day – what does that mean in terms of annual returns?

Let’s assume 20 trading days in the month, and no compounding. If you average $50 in net profit each day, this works out to 10% per month or 120% a year***. Have you watched the financial news networks lately? How is the hedge fund industry doing these days? Stock index products – how are they doing? You get the idea. Generating 120% per year net of costs is not a cakewalk. If it were, I would not be writing this right now – I’d be executing that strategy from my yacht in the Mediterranean.

One main idea here is – if you are planning to truly make a living on a $10,000 futures account, unless your standards of living are below what mine were my sophomore year at the University of Iowa (they probably aren’t – trust me), then perhaps you need to re-think things. It’s not us trying to burst your bubble, but there is a lot of chatter out there pitching a pipe dream. And we find often that people believe they are going to make $200 a day on a $5,000 account. This might happen over the short run, but it’s difficult to sustain over the long run because of the risks needed to generate such a return and the fact that you are human and eventually you’ll slip up and make a mistake, and it may be costly.

I’m not saying that you should not open an account at all with a small amount of money. We have seen success stories with accounts that began modestly. But if you do go this route (remember – only deposit risk capital into a futures account – money you can afford to lose), have a clear, well-defined purpose for that account so that you can best position yourself to avoid mistakes that are associated with trying to squeeze too much out of it.

***If you know of a reliable investment where you can net 120% per year…please let me know =)

Stock Traders, Take Note

I had a very interesting conversation with a prospective customer recently about his efforts to convert from equity trading into futures trading. This person had a great deal of experience actively trading individual stocks, as well as indexes and even highly leveraged ETFs. The conversation was an eye opener for me in terms of how I need to speak with equity traders about perhaps one of the most important concepts of futures trading – leverage.

We were discussing his foray into a demo of our InfinityAT trading platform, and actually send me a copy of a trade log to review; asking what I thought. The 1st thing I noticed were the 20 lot trades. “20 lots per trade?” I said to him. His response: “I’m just trying to replicate what I am used to doing in my stock account”.

This got my brain turning. Let’s assume he trades SPY (the cash version of the S&P 500 Index) in his equity account. How much SPY would he have to be trading to get the equivalent of 20 E-mini S&P futures contracts? Let’s do the math.
Right now the price of the ES is 1237.00. Each point is worth $50. This means that the “full contract value” of one contract is $50 x 1237, or $61,850. Multiply that by 20 contracts, and you get $1,237,000. This is the full contract value of his 20 lot ES trade.

It’s pre-market as I write this, but it looks like the SPY is going to open around $125. This means that if he is trading with zero leverage at his stock broker, he would need to trade about 9900 shares of SPY with an account size over $1.2 million in order to take a position size worth the same as 20 ES futures contracts. Even if his broker gave him the most aggressive available leverage of 4:1, he would need over $300,000 with his stock broker to take the same position.

At this point, one can see the attraction of the futures markets over the equity markets – the amount of capital we require to trade 20 ES contracts is a tiny fraction of what is required by the stock broker, even at the most aggressive 4:1 leverage they offer. (Note – the higher the leverage, or lower margin, the higher the risk of the trade. Leverage can magnify gains but it also can magnify losses). If you control your risk judiciously and have an effective system, you can generate higher returns on your capital with futures trading than with stock trading, simply because the leverage is higher. However, no matter what, you should only deposit risk capital into a futures account. You may lose all or more of your initial investment. You should never deposit money into a futures account that if lost, would hamper your lifestyle or lengthen your retirement horizon.

Throwing numbers around like $1,237,000 really put things in perspective for this prospective client. He was planning to trade a futures account worth about $25,000. What an eye opener. Trading 20 ES contracts with $25,000 equates to almost 50:1 leverage. While Infinity offers low margin in an effort to remain competitive, we do not encourage people to begin trading this way, for obvious reasons. I asked the customer where he got the idea to trade 20 ES contracts. He told me it just sounded strange to go from trading thousands of shares of stock to just a few futures contracts. He thought that unless he traded 20+ ES contracts that he was not getting more “bang for his buck”.

This prospective client has since thanked me for the wakeup call and told me that he has gone back to trading 1-3 contracts on the simulator for practice. This makes his time on the simulator more productive and allows him to set realistic goals which can and will be the subject of an entirely different post.

When you trade a particular market, make sure you understand the full value of the asset you are trading. Not just what the broker offers for day margins, and not just what the exchange asks for to hold an overnight position. Understand total value of the asset you are risking your capital with so you can truly get an understanding of the amount of leverage you are using when you trade. It really puts things in perspective.