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the Sea of Japan is theirsthe Japanese and the Chinese notwithstanding! What do you think the yen will do? That's right, collapse. After four days of downward panic moves (there are no limit moves in the front month) is your loss limited to the $5000 you put up? Hardly. Your house is being auctioned off! So what was your risk? Granted this is an extreme example. However, the underlying concept is totally valid. |
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Your risk in actuality is your entire net worth. Kind of scary isn't it? ''Just great," you must be thinking. "How do I define risk?" The best answer I can give you is that your risk is the amount that the potential move could adversely affect your equity. To determine the amount of actual dollars at risk, look at a chart of the contract you are thinking of trading in, and find the last time it had a moderate move up or down (lasting at least a few days). Then calculate how much that move represents in actual dollars. Now multiply that amount by the number of contracts you are intending on trading. It is a real eye-opening exercise, let me tell you. Another concept to remember is that if you go long and a cataclysmic event occurs that makes it impossible to exit the long position, the absolute lowest the contract could fall is to zero. Your maximum loss is defined and limited to the value of the contract. However, going short leaves no finite, defined limit to the potential for a cataclysmic loss, since the value of the contract could theoretically go to the moon. |
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For example, on 12/30/98 May 1999 corn had a low of 220.5 and rallied for six trading days, and on 1/8/99 it had a high price of 231.0 for a total move of 10.50 cents, or $525. So if you go short on say, 2/10/99, and place a stop at 228.0 risking a couple of cents or $100, in actuality you are risking more like $525. The good news about looking at risk from this perspective is that for all intents and purposes the $525 is the maximum theoretical loss. |
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So what is a trader to do? You should realize that as a trader you will be trading your absolutely worst when you first start out. Therefore, you should define exactly what money management rules you are going to employ. For starters I would highly urge you to use the common guidelines of 50 percent of capital for margin deposits, no more than 25 percent of available capital for margin in related markets (preferably less), and no more than 4 percent of total capital on any one trade. |
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You must be able to define your stop loss point exactly. You must be able to determine what the potential for profit is, and how that relates to the |
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