When building a futures trading system one of the most critical aspects is how it’ll identify its position sizing. Specifically, how it will determine how many contracts to trade once it is getting a buy or sell signal.
One of the finest methods to do position sizing is through a formula designed to normalize the markets for volatility. This way, a market with high volatility trades much more carefully than a market with low volatility. In other words, the high-volatility market trades with less contracts than a low-volatility market.
The next consideration is how much of the account to risk for each trade. As a rough guide, it’s best to risk no more than about 1% to 3% of the account size for each trade. Hence a $100,000 account should never risk more than about $1,000 to $3,000 for each trade.
Once a trader has determined the risk for each trade and the market’s volatility they can then work out the contracts to trade with this formula : ( account size * risk a trade / market volatility ).
Another consideration is the risk for each sector. Traders should never risk more than about 5% of the account at one time in a given sector. Therefore the risk in highly interrelated positions like crude oil, heating oil and gasoline should be summed together. It’s this mixed risk in a correlated sector that shouldn’t exceed about 5% of the account size. Violating this rule may cause traders to be too reliant upon one sector and voids the benefits of diversification.
Besides risk for each trade and risk for each sector one should consider the total risk at any specific time. This is the amount one would lose if every single trade they were in exited at the same time at a total loss. This amount should not surpass about 10%.
By managing risk, and carrying out position sizing this way, one can significantly cut the risk in trading. Finding trading software that may compute all these position sizing rules is very hard. As far as we know there are only two software programs that may do this in the right way. One is Mechanica and the second one is Trading Blox.
This article directory limits us on the size of the piece we can publish. Therefore traders needing to learn more should visit DH Trading Systems by clicking on the above links.
Futures trading is risky and is not suitable for all investors. Past performance is not indicative of future performance.
This article was written by Commodity Trading Advisor and trading systems Developer Dean Hoffman. For more information please click on the links.
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