The Golden Rules of Trading

Welcome to the exciting world of Futures trading. Over the last 15 years Futures trading has become one of the most exciting and lucrative arenas for non-professional traders to get involved in. The Futures markets have expanded from the better-known commodities such as Corn, Cattle, Sugar, etc, to products ranging from Currencies, Equity Indexes, Energies, and Debt Instruments. During that expansion options on futures have also become available. This plus the added environment of online trading and the hundreds of web sites devoted to futures trading (including this one) have attracted thousands of new participants in the trading of Futures.

While that is very positive for the industry as a whole, the influx of newer traders has created a segment of participants that need to be educated as to the workings of the Futures markets. The following list of ?Golden Rules? is by no means exhaustive. It is directed to newer participants in these markets and offered from hands on experience in dealing with newer traders. It is a well-known fact that 85-90% of futures traders lose money. The majority of those are newcomers who either haven?t taken the time to educate themselves, or aren?t shown how to educate themselves. The purpose of these ?Rules? is to help newer traders with some of the basic principals that professional traders inherently live by. They are presented in no particular order, as every one of them is significant. They are presented for the express purpose of starting the education process for the newer trader. So lets get to it!


Too many times beginning traders find themselves in the enviable situation of having a nice winner on the books. Sometimes those winners can be 50-75 % of a particular account's value. While traders always want to get the most out of a market's move, many newer traders let greed and ignorance get in their way. They think that the market will continue in their way forever. Well, the truth of the matter is that markets don?t go straight up or straight down. They fluctuate all the time, sometimes with a tremendous amount of volatility. If you have a winner on the books protect it. Don?t let it turn into a loser. There is nothing more demoralizing to a newer trader than to have a 10K winner turn into a 20K loser. And don?t think it won?t happen to you, it happens to every one.


One of the most common things written in books and articles on trading (whether stocks or futures) is to have a plan and to stay disciplined to that plan. That means know the following BEFORE a trade is put on. Where is the entry point and why? Where is the protective stop going to placed? Where will you begin to take profits? Knowing the answer to all 3 of those questions BEFORE you enter a trade will prevent you from having to make tough decisions as the market is moving. You will already know what to do when the market moves. Nothing is worse than having your broker call you up and tell you bad news AND him expecting a decision immediately on what to do.


This goes along with having a trading plan. Knowing how much you are willing to risk on any one particular trade is just as important as knowing how much you are willing to risk on trading in general. An account should always be opened with risk capital, moneys that you can walk away from if lost without any hardship. That amount of money is up to the trader. Your broker should be made aware of that amount as well. As far as individual trades, know where you?re wrong, i.e. have stops in place so a market can?t get away from you. Also, be aware that options can be used as a hedge against a futures position. Most new traders are unaware of how that can be done, but it is a vital component of professional trading. Ask your broker how that works.


This is a bit of the first 3 ?Rules? reiterated for a big reason. Most new traders seem to have an aversion to profits. That seems like a ludicrous statement but it is nevertheless true. Newer traders seem to all have the habit of thinking that the market will always go their way, it will never reverse. So Mr. Greed tells them to stay with the trade forever. Well, that simply never happens. You have to exit a trade to turn that position into cash. And settle yourself to this fact. You will never sell the exact top of a market or buy the exact bottom of a market. Professional traders don?t even attempt to do that. So why put that type of pressure on yourself as a newer trader. If it happens it is generally luck. If you have profits TAKE THEM. You will always be able to renter a new position. Tomorrow is another day. There are always other trades. The markets have been around for hundreds of years and they?re not going anywhere. So that one trade that is making a lot of money IS NOT the only trade you will ever make. It?s a lot like eating chips, you can?t eat just one. In 10 years of working with retail clients, I have never seen a newer trader make 1 profitable trade and then close the account. I have seen, unfortunately, the opposite.


Trading is an extremely emotional exercise. In fact, 85% of trading is knowing how to handle the psychology of trading. The rest is actual ?book smarts?. It is emotions that move markets. The emotions of fear and greed being the most prominent. Fear generally makes a market move lower, and greed generally makes a market move higher. Learn to divorce yourself from your fear and greed when making trading decisions. Decisions based on emotion almost always are the wrong decisions. John Templeton, founder of Templeton Funds, was once asked how to know when to buy or sell a market. His response was simple yet very complex. ? I buy markets when everyone else wants to get out of them, and I sell markets when everyone else wants to get into them?. Meaning, mass thought process played an important role in his decision making process. When everyone else is scared to death to be in a particular market, he would like to buy. When everyone else thinks a market is the next big killing, he wants to sell. The Templeton Funds were one of the most successful groups of funds on Wall Street. Money is one of the most important factors in a person?s emotional well being. That may not be the right way to live but it is a fact of life. Money can cause divorce, suicide, litigation, exuberance, and joy. In the long run, it is just money. Don?t let your emotional attachment to it cloud your decision making process.


Many times over my career with retail clients someone has called me up to ask, ?How are my investments doing?? The sarcastic answer, always left unsaid, is ? I don?t know, call your financial planner?. Trading is a short-term thing. You enter a position with the expectation of exiting it quickly. That can be anywhere from 30 seconds to 3 months depending on your strategy. Investing is a longer-term process, lasting years generally. The only thing the 2 have in common is that you need to exit a position to turn it into cash. Besides that, they are inherently different. Realize this when trading Futures.


Margin is one of the great advantages to trading Futures. The margins on futures products tend to be far less than that of stocks. That makes Futures vehicles more highly leveraged. That means that those markets can move much faster. Take that one step further and you realize that the profits as well as the risks can come quickly and in larger magnitude than other forms of trading. The margin on your account is an extremely valuable tool. It is an amount that tells you how much of your account is being held to the side for margin, and therefore how much cash in your account is available for new trades OR adverse market movement. Margin Calls are an extremely valuable piece of information. A Margin Call occurs when there is not enough cash in your account to hold all the positions in the account. A Call usually occurs when markets are moving against the positions in the account. Therefore a Margin Call is a red flag telling you that the trades you?re holding may not be working. That something is wrong. That you have become over leveraged. Most firms will allow a client to meet margin calls in a day or 2. But, some circumstances occur when a firm may give you as little as 1 hour to meet the call. That is telling you that you?re in trouble. A common guideline is to have no more than 50% of your account used in margin at any one time. This is also where options can be used to help offset margin. If an option is used as a hedge, margin is often lowered or non-existent.


There is a common language used by employees in the futures industry. Learning it can save you a great many problems, as well as, a lot of money. The phrasing of an order to a broker is paramount in the execution process. Not a day goes by when a newer trader wants to go short a market and yet says to ? buy me one? assuming that the broker knows what he is thinking. If you think a market is going lower you want to sell (or short) the market. If you think a market is going higher you want to buy (or go long) the market. If you?re exiting a position you say the opposite of what is in the account. Meaning if you are long 5 Dow and you want to exit, you say ?Sell 5 Dow?. If you?re short 5 Dow and want to exit, you say ?Buy 5 Dow?. A buy vs. sell error is one of the most devastating errors in this business. It is a main reason why orders are taped, so that there is a record of what exactly was said. Because a broker has to do exactly what you say. A good broker will help you through this process and teach you the proper terminology. There are also various types of orders at your beck and call. There are market orders, limit orders, stop orders, stop limit orders, fill or kill orders, market on open orders, and market on close orders just to name a few. They all have different meanings and effects. And to add to the confusion, some markets except some and some markets don?t. So ask your broker about the best type of order to use, and learn about them. In the same vein, market orders are the quickest and most effective way to get something done. Too many times I?ve seen a newer trader try to squeeze the market and not get filled. I?ve seen traders with nice profits and the market almost exactly where they want to get out, but enter a limit order just a little above where the market is trading, only to see the market drop with filling him. If you are at a point where you want to get out of or into a position, the easiest way is with a market order. Yes, you will experience slippage but at least you?re filled. This is especially important when taking profits.


There are 2 statistics that all traders should watch. Open Interest and Volume. Those 2 numbers will tell a trader how deep a market is. The higher the Open Interest and Volume, generally the better the service in that market. AND more importantly, the more liquid a market the more fluid it moves. Open Interest is a number that tells you how many existing positions there are in that market. Volume tells you how much trading has been done in that market. If the Open Interest in a market is low, what that is telling you is that there are not as many market participants in that market. Many times newer traders ignore Open Interest and trade market with usually low O.I like Rough Rice, or Pork Bellies. The say that they like those markets, that they have an affinity for them. But what they don?t realize is that if they are Trading Rice and the O.I is 2-3K, 1500 of it may be in positions from General Mills or Kellogg?s to hedge their business risks. Unfortunately many newer traders find themselves on the opposite side of those big positions. Who do you think is going to win that battle? Joe the Barber from Iowa or General Mills. The point being, the larger the Open Interest, the larger the number of market participants, and the less likelihood of a market being controlled buy a large institution. This also leads us into the IMPORTANCE OF FIRST NOTICE DAY AND LAST TRADING DAY. First notice day and last trading day are times determined by the exchange when holders off open position have to either exit trades or declare the desire to take delivery or deliver on the underlying asset. In other words, it is when all the speculators get out of the pool. The Open Interest in markets starts to drop when you get closer to first notice day, thereby thinning out the number of participants. Why is this important? Many times I?ve seen a newer trader hold a losing position going into last trading day with the hopes that the market will turn around in his favor. The problem is, as more and more traders exit that market due to first notice day, the trader with the losing position can get stuck in a market where it is him and a handful of other smaller traders and 1 or 2 very large institutions, Once again, who do you think is going to win that one? Please pay attention to Open Interest, Volume and First Notice and Last Trading Days.


Don?t be afraid to ask questions about trading. There are a variety of sources for information available now. There are hundreds of web sites, access to other traders, newsletters, etc. But most importantly, ask your broker. There is a common misconception that your broker doesn?t care whether or not you make money. Speaking as a broker for 10 years, that is absolutely insane. A good broker wants you to make money because you will most likely continue to trade with him if you?re profitable. Also a good broker will encourage you to ask questions because he or she knows that the more informed a client is the better off that client is. The communication process between you and your broker is of the utmost importance. And lastly, a good broker will want to educate you so the likelihood of errors and miscommunications is greatly diminished.


This is also a repeat, but bears repeating. Be patient and think everything through before making a decision. Avoid the ?Chicken Little Syndrome? where it looks as if the sky is falling. It isn?t. Take your time and if you find yourself getting too emotional, compose yourself. A well thought out decision is usually better than a hasty one.


The cash you send into a trading account is your money. Only you truly know how important it is to you. A broker or newsletter writer or T.V. commentator doesn?t know the true value of your money. It is inherently your responsibility for that money. Trading funds should be risk funds. Meaning that, if all of it is lost, you will not suffer any adverse affects to your life. In other words, don?t risk the rent money on trading. Anything can happen in these markets (and often does). That is why they are so exciting.


Although the similarities are there, trading and gambling are NOT the same thing. They share many common characteristics, most notably money management, but they are different. In Vegas you?re not allowed to keep a pad of paper on the Black Jack table and count the number of face cards that have appeared. You?re not allowed to use a calculator at the Craps table to help you with the odds. You can?t chart Red and Black at the Roulette table. All of these advantages have been taken away from you for a reason. They can make you a better player. So instead the Casinos not only won?t let you use them (you have to do it all in your head), they give you free liquor to make sure you have a harder time doing it in your head. Futures? trading is different. Not only can you chart anything you want, there are several hundred technical tools available to you to help you. And you can use them for free on many web sites. There are thousands of books, course, etc. Use the tools available to you, learn them, and let them help you. But don?t treat this like Vegas.

Trading can be one of the most rewarding experiences of your life. Not just financially but also mentally. There is certain feelings of accomplishment traders feel when they do their homework, plan out a trade, and execute the trade to profitability. Some newer traders take their time to learn the business and graduate into more professional traders. Sadly, others do not. Take your time and enjoy.

As stated earlier, these ?Rules? are by no means meant to be exhaustive. They are not the Key To The Vault. In fact there is no Key To The Vault. They are meant to help the newer trader in his or her journey through this industry. This business can be costly and humiliating, and it can be lucrative and enlightening. Trading is the last bastion of true capitalism on earth. It is a fascinating business that I hope you enjoy as much as I do.