Sunday, October 15, 2006

Why so many futures trader fail

Most of the futures traders I know have started trading stocks and somewhere along the road decided to try their hand at futures. And most trade something between 2 to 5 contracts using the margin given to them by their broker to the fullest. For example, for trading 5 Russel contracts intraday an account of 10.000 USD would be sufficient. You know I don’t recommend that, actually I consider that reckless trading and a sure way to disaster and bancruptcy, but it is possible and it is done.

Have you ever stopped to consider how many shares these 5 Russel contracts equal to?

I don’t look at the contract value. I use a very simple approach to determine this. I just say a tick is a tick. It doesn’t matter if this tick represents 0.1 (eg. the Russel) or 1 (eg. the Dow futures) or 0.0001 (eg. most currency futures) or 0.000001 (eg: the USD/YEN currency futures) points.

A single tick usually pays 10 USD to 12.50 USD. (I know the Dow pays less and the Bonds pay more, but let’s concentrate on the most common tick value)

To earn 10 USD per tick with a stock, you need to trade 1.000 shares, as stocks are now priced in pennies and the tick value is 0.01. Of course there are a lot of stocks, which move in bigger increments, which never ever have a trade at every 0.01 increment. But there are also futures which move a lot faster and jump easily 10 tick levels. If you ever tried trading the ZG Gold futures you know what I mean.

On the other hand there are a lot of stocks (examples coming to mind are MSFT, CSCO and a lot of other high volume stocks) which trade at every 0.01 tick level quite heavily and for our comparison to work we will look at these.

So if you trade 5 contracts ER2 with your 10.000 USD account, could you trade 5.000 shares MSFT as well?

To trade 5.000 shares MSFT fully margined (4 : 1) you need an account of at least 36.000 USD and that’s the absolute minimum. Considering the volatility of most of these high volume stocks a 2 : 1 margin rate would be more appropriate for most traders, meaning with a 36.000 USD account you would reasonably trade something between 2.000 to 3.000 shares MSFT.

Still, I’m sure, most futures traders would think nothing of trading even swing trading 3 Russel contracts with a 10.000 USD account, not to say 5 to 10 contracts with a 36.000 USD account.

This has nothing to do with inappropriate risks. This has to do with perception.

Most consider trading 1 contract not worth the effort. But trading 1.000 shares, well that’s something different. Most start trading 1 lot or 100 shares and work their way up to 1.000 shares or 10 lot sizes. But with futures, if you compare them with stocks, most start with a 20 lot.

Do you now really wonder why a lot of traders fail trading futures?

1 comment:

Christophe said...

Chris,
IMHO most traders fail because they rely on technical indicators to make all the decision for them.

Leverage only accelerate the failure.

It is like driving ; if you dont know how to drive, you will probably kill yoursel. And speed will only strenghten the probability that it happens. It is the lack of knowledge of driving and not the speed that is the main reason.

Most traders you will find in the chat rooms do not understand who are the main players, their main motivations and how they trade.

They dont know neither how the fundamentals affect the markets let alone the big players.

Trading is a war, we try to beat each other up and take each other money. If you dont agree let me ask you what you feel when you are taking up a beating and having a red day ??? are you totally zen or do you feel the pain? well gess what, someone else whilst you are feeling the pain is having a good time enjoying the good feeling of making money. The people who dont feel the pain are the people who can afford to loose.

Whenever the price goes up or down, someone is smilling and counting the money whilst another is praying and suffering. This is trading in few words.

Most traders start trading as if it was a nice social activity without realising that they throw themself in an arena full of sharks and lions.

It is just really insane to think that you can rely on few indicators (be it CCI, Stochastic, MACD and the all lot) to consistently beat the markets. Totally uterly insane!

To be able to succeed in the market you need in my opinion 3 things:

- knowledge
not technical indicators knowledge but market knowledge which is quite different. like knowing how the big boys trade, how the locals trade, why the trading programs do what they do etc...
you got to know when big players are moving in and out and how desperate they are.

- financial backing and size.
in trading size matter. in fact that the only thing that matters (once you know how to trade).
if you know how to trade but you are not using size it is like putting Michael Schumacher in a VW Polo and ask him to compete against Ferrari.
You wont go anywhere.
You also need financial backing to make sure you can take the losses and carry on trading.

- mental preparation
When i was in chat rooms, most traders (including me at some point)
where talking about weather, the thing they did or are doing, and even worst, saying stuff like of i am long i am short, just covered...

Lets put it this way ; if you were racing in Formula 1, driving the most powerful car in the world, would you take time to have social conversations and commenting on your driving OR would you be 200% focussed on the task at hand?

In the place where i work, when people trade they trade and you better not approach them ; then when they want to have fun they do have fun off the trading floor/desks.

I hope that if someone ever read this post it will make them think and avoid wasting years like I did on trying to find all the technical indicators that would make me money.

There is nothing else you need than a naked chart. absolutely everything is in there. if you learn to take the time to read what a chart is saying you dont need anything else, no indicators, nothing. if you learn to understand the market conditions and the motivations of what we call "the paper" you will only need a clear naked chart and a ladder to trade.

Best Regards,
Christophe