In the most recent credit crisis, over-leveraging threatened great economic disaster upon the United States, and leveraging is the name of the game in trading futures contracts. Leverage will either mazimize the potential gain in your position, or it will maximize the potential loss in your position. You ability to manage leverage to your advantage will, to a certain degree, determine the level of successs. Compound the tendency of novie traders to overtrade and you have a recipe for disaster in your trading account.
Not every trade is a winner, and the highly leveraged nature of futures trading demands careful management of your trading positions.
Suppose now that you one thousand dollars in your futures account with a broker that set the emini day trading margin at only $500. Suppose also that what you wanted to trade is ES, the emini contract of S&P 500. Since one point of this instrument is equal to $50 and its price is these days (June 2009) about 950, it is quite easy to find out how much dollar value you can control with your $1,000. It is simply $50*900=$45000. That’s right: your paltry $1,000 (or even $500 in principle, though only theoretically) can control as much as $45000.
45,000 thousand is a fairly large number for most traders, and most fail to grasp the gravity of their position size. On the other hand, stocks are a far different animal, where margin account minimums are set at 50% by Regulation T. Your first observation should be, “that a heck of a lot of difference from the futures margins.” Leverage is what making trading futures contracts so attractive to experienced and novice traders alike. There is a downside, though. An experienced trader is well aware of money management techniques to control his risk exposure. Risk control is achieve with contract size control, aggressive stops and general experience.
For myself, I don’t like to risk any more than 10% of my account on a given trade. That is a fairly agressive stance, as some consider 5% a more acceptable risk level. Of course, novice investors, smelling the allure of untold riches, routinely trade much higher lot sizes and expose themselves to extraordinary account risk. For example, if I were trading a 10K account I would probably trade 1 ES contract or 1-2 YM contracts, at the most. This sounds like a fairly conservative approach, but you can easily earn 500 bucks a day using this strategy.
If you are trading more than 5% of your portfolio, and at the most , you are exposing yourself to great peril. It is important to match the trade risk tolerance to your account size and trading experience
It is the overriding greed aspect that forces traders to trade inappropriate lot sizes, and greed is one of the primal desires a trader must learn to control. It is much better to hit singles in your trading operation, than to swing for the fence.