Sizing A Futures
by Jay Kaeppel
While most traders start out working on a trading system,
they forget that the amount of starting capital is equally
important. Here are some guidelines to consider.
Novice traders focus their attention
on developing a system for
entering and exiting the markets.
In fact, an entire industry has
been spawned to facilitate trading
system development. The
age-old quest for the Holy Grail
fuels the simplistic attitude
among new traders that if their
timing is good enough, everything
will work out. Only after a
trader has become seasoned and
taken some hits does his or her attention become more focused
on money management. While money management is a broad
subject, one crucial topic — sizing an account — is key.
Before a trader can start trading a portfolio of different
contracts, he or she should determine how much capital is
needed. Unfortunately, topics such as sizing an account tend
to be an afterthought for most new traders — until, that is,
they suffer a drawdown of frightening or ruinous proportions.
The dangers in failing to size an account properly are three-fold:
The first and greatest danger is that you might tap out
(that is, lose all your money). Consider the naive trader who
opens an account with $20,000 and begins trading a group of
markets using the trading system he spent hundreds of hours
developing. While the trader has total confidence in the buy
and sell signals generated by the system, he fails to do enough
homework regarding expected equity swings. He doesn’t
know that the portfolio/system combination routinely experiences
equity swings of $15,000. Of course, he could get
lucky, start making money right off the bat, and then be able
to sit through a subsequent $15,000 drawdown. It’s more
likely, however, he will suffer a $15,000 drawdown at some
point and stop trading altogether because he was not prepared
financially for the huge percentage swings in equity.