Managing Risk with Futures Trading

Whenever we look at how to manage risk with a trade, the first place to start is to assess how much risk you are able to take on. An extreme example of risk that one would not be able to properly manage is if they took a trade that would result in their losing all their capital if the trade moved against them in the slightest way.

While this isn’t really possible with normal futures trading, as you can’t really get enough leverage to go broke on small movements, you certainly can get there if you are not careful. Trading the futures market with contracts for difference, or CFDs, can provide traders with leverage up to 1000 to 1 though, and if you’re trading with that much leverage, a one tenth of one percent movement against you will certainly cause you to lose your whole account if you put it all in the trade.

Managing Risk with Futures TradingEven this could be properly managed though if one was both willing to take on this much risk and monitored things closely enough, as well as had the skill to pull this off. So, we don’t want to assume too much here, in this case for instance assuming that such a strategy would be suicidal, because one trader’s suicide might be another’s ticket to great success.

It will suffice to say though that futures traders wouldn’t normally want all their funds out there at 1000:1 leverage, if they could even get this much of it, and there are plenty of situations where a trader may over leverage themselves.

We do need to ensure that we are not doing this, although there are no hard and fast rules here, like some advisors suggest,  such as putting no more than a certain percentage of your account in any one trade and the like.

Rules like this are often going to end up being too broad, as the other considerations that determine both trading success and risk tolerance are going to matter as well, and sometimes matter even more.

We do need to be aware of the fact though that there is going to be what we could call an organic risk tolerance with trades, which apply regardless of one’s risk preferences, which are something different.

Over leveraging oneself, beyond what is reasonable when we take everything into account, is an example of this. This isn’t all about reducing risk though, as risk and reward go together, so it may be the case that a trader needs to take on more risk, and this isn’t that uncommon.

The Real Risks of Futures Trading Aren’t In The Trades Themselves

Futures trading, like all forms of financial trading, are not based upon random outcomes, even though randomness is an element of any trade. We do know that price patters with securities, including futures, are not random, and there’s actually nothing at all that is random about these markets.

Our ability to be able to successfully predict these price movements over the periods that we are looking to trade in though is going to be uncertain. If this were random, our wins and losses would even out net of trading costs, but in actual fact we will be able to predict our trades with some degree of positive or negative outcome over time, based upon our trading skills.

Our overall expectation is going to therefore matter a lot as we look to assess risk, and if we are trading with a negative expectation and do not improve enough, it’s not going to matter much whether we lose all of our money on a single trade or over time.

We still may want to preserve more of our capital though to give ourselves this opportunity to improve, especially if our trading capital isn’t easily replenished. It is better to learn with smaller losses than larger ones though, and that’s the idea here.

The first and most significant risk in futures trading is therefore the risk that we don’t know enough about what we’re doing to have a positive expectation of any sort. We can call this strategic risk, and our further decisions on how much we’re going to risk in the trades themselves will depend upon this.

If our strategic risk is higher, we’re going to want to be more careful in our trading, becoming more risk averse than normal. If our expectation is a positive one, we will be able to take on more risk than normal, because shortfalls in particular trades will be more easily rectified.

This is really the starting point for all traders, to honestly assess their expectations and adjust their risk management in accordance with the overall risk that is present in their strategies.

Futures Trading Risk is All About Strategic Exposure

At the level of individual trades, or with groups of trades that are positively correlated, it really isn’t so much a matter of your trade size, like many believe and suggest. Trade sizes matter, but only to the extent that they may involve more exposure according to your strategy.

We can define exposure risk as the losses that a trader is prepared to accept prior to exiting the trade, for instance what sort of stop loss one will use if one uses stop losses, or any other means by which one may decide how much one is prepared to lose in trades.

This may vary by trade but we can assume that there’s an average level that one will want to endure prior to exit. This of course is the real risk because it decides directly how much one will lose.

We can call this amount our strategic exposure because it’s determined by way of our strategies, and hopefully we do have one when it comes to exiting our trades, otherwise we’re going to be exposing ourselves to way too much risk.

If not, well our risk is going to be unacceptably high because we are risking losing the entire amount we put up for the trade and then some.

Managing Strategic Exposure

Managing strategic exposure properly is not merely a matter of looking to exit trades with a certain level of loss, as this must be integrated into our overall trading strategy in such a way as to not yield too high amounts of losses overall.

One can exit trades very quickly in such a way that one will end up losing far more trades than one will win, as well as losing more money on these unprofitable trades than is gained with the profitable ones.

All decisions must be made from the perspective of how it adds or subtracts to one’s overall trading profitability, including how much exposure one is willing to take with a given trade.

As a general rule, the longer the anticipated time frame of the trade is, the more room you will have to give it in terms of its acceptable downside. If you are trading with one hour bars though  and are looking to follow a certain trend, you’re going to need looser stops than you would with using one minute bars for instance.

The reason for this is that a certain movement against you may be perfectly reasonable and expected with the longer term trade, but the same movement may completely violate the trade on the shorter one, perhaps indicating a reversal of the one minute trend but well within the continuation of the hourly trend.

If, for instance, your strategy is to exit the trade if the price drops below a certain moving average, it will take a lot bigger drop for it to go below the same moving average on an hourly chart than it will with a minute chart.

Shorter time frames also involve managing risk better due to their providing exit signals earlier or even much earlier than longer term scales. This does need to be properly balanced with their tendency to get you out of trades too early though.

Choosing the Right Risk Management Strategy For You

To sum up a little here, there are several factors that must be properly accounted for when looking to come up with a good risk management strategy with futures trading, or any other sort of financial trading.

Perhaps the most important consideration is what your level of expectation is at the present time with your trading, as well as the level that you may be improving at. Trading isn’t so much about the outcome of particular trades as it is the direction that your trading is headed in or may be expected to head in.

It then comes down to how much it is wise to leverage not just your capital but your skill, and successful futures trading really comes down to leveraging your skill properly. To the more skillful traders, this will mean taking more advantage of financial leveraging, as it isn’t the money you’re leveraging, it’s your greater skills.

Conversely, if one is an unproven trader or has not acquired the sufficient skill level to have.a positive expectation yet, more care must be used, and in this case we do not want to leverage our skill so much since we’re not there yet, and we’d be leveraging our disadvantage.

One can still over leverage oneself and overexpose oneself as far as risk is concerned no matter how good of a trader one is, so it’s never a matter of risk management not being important.

With skilled and successful traders, it’s a matter of both not taking on too much risk and taking on enough risk, at least as far as leverage is concerned.

You wouldn’t want to be killing the futures market and not be leveraged for instance, but you also don’t want to be over leveraged to the point where your skills cannot compensate for unacceptable trading outcomes.

If one is less skilled though, much greater care must be exercised and unless you actually have an advantage, it is questionable whether leverage should be used at all. In addition, one must be extra diligent to make sure that whatever losses one exposes oneself to by way of their trading strategies are not ones that will expose them to too much risk.

Eric Baker


Eric has a deep understanding of what moves prices and how we can predict them to take advantage. He also understands why so many traders fail and how they may help themselves.

Contact Eric: [email protected]

Areas of interest: News & updates from the Commodity Futures Trading Commission, Banking, Futures, Derivatives & more.