The National Futures Association says the way you participate in trading depends on four factors: your knowledge and previous experience in trading, how much time you are able to devote to trading, the amount of capital you commit and your individual temperament and risk tolerance. If you’ve watched the market for years but haven’t yet taken the plunge, there are several factors to consider so you don’t belly-flop into the trading pool.
#1: RESEARCH
The first step to trading is research. If you’re trading futures, understand the contract you are trading — minimum tick size, how it is quoted and its normal daily range. There are several books and online resources for trading, including Futuresmag.com (see “Reliable sources”).
“Be wary of things that sound too good to be true on the Internet. Anything that indicates that learning to trade or trading successfully is easy [is] a huge red flag,” says Jeff Quinto, trading coach with electronicfuturestrader.com.
If you’re trading options, education is especially important because options, while technically less risky, are more complicated than futures. Controlling risk is one of the biggest advantages to trading options vs. futures, but you must first understand how they work. “Once you understand [options], they are a much more sensible investment instrument than everything else because you can control your risk better than any other product,” says Tony Saliba, CEO of BNY ConvergEx Group’s LiquidPoint.
Research also is crucial. Brian Dolan, chief currency strategist at GAIN Capital, suggests familiarizing yourself with data reports for currency pairs and central bank speakers’ schedules so you’re not caught by surprise. Factor these events into your trading strategy and prepare for them.
Although there are many training and coaching firms, exchange Web sites, which offer education centers with product guides, online seminars, instructional videos, courses on products and free webinars, are good places to start. NFA has free one-hour online classes on trading futures and forex and guides on how to compute the cost of trading futures. The Options Industry Council Web site, www.optionseducation.org, has an extensive educational library for options traders.
#2: CREATE A TRADING PLAN
Next, you need to develop a trading plan that you can stick to. Quinto says your plan should include how much you’re willing to risk in a given day and for a given trade, what hours you’re going to trade, what contracts you’re going to trade, how much loss you’re willing to take on each contract, what you’re going to do if you lose three trades in a row and how you’re going to keep track of your trades.
Even the best trading plan is useless if you don’t stick to it. “The reason most people lose in trading is that they don’t have a plan and if they do have a plan, they don’t follow their own rules. If you have a plan and follow [it], you’re ahead of 95% of the starting traders,” Quinto says.
Saliba says that discipline is important in trading and he stresses the need for money management. “Have a set of rules written down and follow them. You could have the best trading strategy and screw it up with poor money management,” he says.
Also, take responsibility for money management yourself. Don’t leave it up to your broker.
“Don’t take money management for granted. Know what the consequences [of your trade] might be,” Saliba says. “Money management should fit the investment style and risk tolerance threshold of the individual investor.”
Forex traders should develop a plan too. “Have a clear, thought-out trading strategy with entry levels and exit levels both on a stop-loss and a take-profit basis,” Dolan says. “Traders who trade with a plan can take a loss and survive, but traders who don’t trade with a plan tend to get wiped out relatively early. Part of getting started [in forex] is developing a trading style that matches your situation.” Consider how much time you have to trade, how frequently you’re trading and what kind of risk you’re taking.
#3: “PAPER” TRADE
Before you dive into the real market, you should be able to profit consistently in a simulated environment. If you’re trading futures, you can practice on a trading simulator. “Traders that fight [using a simulator] do it at their peril. You can practice and make all kinds of mistakes [that] only cost your pride,” Quinto says, adding, “Treat the simulator as if it’s real money. If you treat the simulator as a videogame, it [will] do no good.”
Quinto suggests measuring your performance on the simulator on a weekly basis. He says you should be profitable every week, making money four out of five days, before you move on to the live market. CME Group’s education center has links to trading simulators available at various brokers.
“Simulating profits” shows Tradestation’s trading simulator. Winning and losing trades may not be the best measuring stick for beginning traders. Bad traders can get lucky and good traders can run into a patch of bad luck, so it is useful to have other measures of success such as percentage of winners, average winning trades and average losing trades. If you are scalping quick small profits, it is imperative that you have a high winning percentage. If you are targeting breakouts, it may be possible to employ a system that produces more losing trades as long as the winners are much larger than the losers.
For options, Saliba says trading simulators can be a good place to start for understanding the characteristics of the underlying (future or security), but then that knowledge must be put into use. “Beginning options traders could start with the technical and fundamental simulators, [and] then use options to refine their trading strategies,” he says.
Saliba suggests doing “what-if” scenarios, using four variables: the price range of the stock, the time to expiration, the interest rate environment and volatility levels, to determine how your trade will play out. Brokers have options calculators that allow you to do what-ifs, but how sophisticated the tools are sometimes depends on the size of your account. One free mock-trading system for options is The Options Industry Council’s Virtual Trading System.
Forex traders can get a feel of the currency market without risking any money by trading in the practice accounts of online providers. Practice accounts have the same prices and account valuation metrics as a live account, and they’re free. To check the stability of online platforms, Dolan suggests conducting the same trade with different practice accounts at different brokers. Make sure you’re comfortable with the platform, and compare spreads and functionality. He suggests monitoring and participating in the practice accounts for three months before entering the live market.
You have to understand risk before you get into trading. If you can’t afford risk, you shouldn’t trade. Gauge risk by calculating profit and loss outcomes before you enter a trade. If your trades are steady and consistent, you’re on the right track. “If your trading account is wildly gyrating, something is wrong with the way you’re handling your risk,” Quinto says.
#4: LEARN RISK MANAGEMENT
While research is valuable and practice makes perfect, real trading is never what it looks like in the books or on a simulator. Sometimes stop orders and market orders are not filled at their price. All trades need to calculate slippage — the difference between your target price and where you are filled — into their calculations. Even highly liquid electronic markets can produce pockets of illiquidity. Beginning traders should not only adjust for the inevitable slippage but avoid trading during times when the market tends to be less liquid.
The amount of slippage to expect is often based on how you enter and exit the market. Are you entering on limit orders, market orders or stops? Limit orders provide certainty but can result in you missing an entry. Stop orders are orders that become market orders once the stop price is touched. You should not assume that you will be filled at your price.
The beginner also needs to understand the limits of the platform he is using and the strategies available to him. Professional traders may have more sophisticated software and market connections, so it is not wise for a beginner using a retail platform to attempt scalping short-term profits because those speedier platforms will almost always beat you to the trade.
#5: SIZE IT UP
After you’ve practiced with a simulator, options calculator, or forex practice account, you’re ready to start trading for real. Find a futures broker. CME Group’s Web site, cmegroup.com/findabroker, is a good place to start but you should also conduct a background check using NFA’s BASIC search engine (www.nfa.futures.org/basicnet/ ).
“Find a broker that will give you the tools [for] pricing, risk analysis, portfolio management and optimal execution,” Saliba says.
Quinto recommends traders start with $15,000 in their accounts, but notes, “Whatever it is, it needs to be a fixed amount. You should figure out how you’re going to learn to trade on x number of dollars.”
While options accounts can be smaller because you are dealing with a “known risk” with most option trades, Saliba says if you don’t have at least $25,000, you’re going to be viewed as a very small account. However, he says each firm is different and what you put up will dictate how much leverage you will be given.
Many forex dealers require a minimum amount of money for each account. NFA advises checking with several dealers and comparing charges and services and understanding how a firm will charge you for your trades before opening an account.
For forex, “If you’re trading minis, you should commit 4-5 times what the minimum account is in order to give yourself some staying power. Only use risk capital — money that would not affect your standard of living. Go in with your eyes wide open,” Dolan says. He suggests not putting at risk any more than 5%-10% of your trading capital on any single trade. “One of the biggest mistakes that a lot of people make is trying to trade the largest position that they can based on their margin. That’s a recipe for disaster because of the high leverage involved. Traders need to understand the margin requirements of their brokerage and what their liquidation policies are.”
While spot forex platforms may provide the lowest barrier to entry in terms of the capital required to get started, the availability of leverage and the larger spreads of mini contracts work against the beginning trader. Futures brokers charge commissions but spot forex trading involves a spread, which in effect can be much more expensive. Beginning traders need to work that into their calculations.
Quinto says that beginning futures traders tend to start with stock index contracts, like E-mini S&P or mini-Dow based on their basic understanding of the stock market and because they are very liquid. For beginners, trading in highly liquid markets is important. “Highly liquid markets tend to be truer to the technicals and the chart patterns. The more participants there are in a market, the more the market flows in a predictable way,” Quinto says.
If you’re trading forex, picking which currency pair to trade requires a little research. By using a practice account, you’ll see how different currency pairs behave over time and can determine which one is right for you.
Three key things beginners should keep in mind are: think small, don’t get too emotional and be patient. “The biggest trap is overdoing it, diving in head first and not recognizing the value of experience,” Saliba says. “Have finite risk in the beginning. If your worst-case scenario can only lose you 10% of your nest egg, that’s a great place to start.”
Keeping your emotions in check also is important. “Nobody likes taking losses, but it’s something that you have to live with if the market decides not to cooperate with your trading plan,” Dolan says.
And don’t expect trading to make you a millionaire overnight. Quinto says that many people take one or two years to break even after they start trading. “People get into trading and think it’s going to be easy. [They] think it’s going to be like learning tennis or something, but it’s much more complicated,” he says. However, you can ease the complications of trading by doing your homework. A little research and a little planning go a long way towards trading success.
