One of the biggest mistakes new commodity traders make is having unrealistic expectations before they place their first trade. The commodity markets are highly leveraged investments, which increase profits for disciplined traders and rapidly drain the accounts of reckless traders.
Commodities can have leverage near 20 to 1, which means a trader will only have to put up around 5 percent to control a futures contract. For example, say gold futures are trading at $1,200 an ounce and each contract consists of 100 ounces. That means the entire contract value is $120,000. The margin to control this contract is only $3,740. Gold normally moves about $10 a day, which equates to a $1,000 daily move on just a $3,740 investment (futures margin). It should be obvious how quickly you can get into trouble if you don’t respect the leverage.
The leverage in the futures markets often stimulates the greed part of the brain for many novice traders and they only focus on potential profits and not potential losses. Profits of 50 to 100 percent can be made in just a matter of a few days if a trader maximizes his or her leverage. Losses of that same amount can also happen just as quickly and this can lead to total destruction of a trading account.
The motto of living to trade another day should always be on a commodity traders mind. The greater the returns one wants to make, the greater the risk one must often take. Therefore, shooting for returns of 100 percent every week will likely result in an account going bust. It usually only takes one wrong move for the greedy trader to destroy an account. And it is only a matter of time before that happens to a greedy commodity trader who has little respect for the risk.
Professional commodity traders’ typically only risk a small portion of their account on any given trade, falling anywhere from 5 percent to less than 1 percent. This obviously lowers their return potential, but it also lowers their loss potential. Losses are part of the game and taking a loss does not hurt as much when it is only a small fraction of the account. You should be able to resume normal trading without any anxiety or frustration after a loss. Losing half your account on one trade will likely cause severe mental anguish.
Think of commodity trading as the turtle winning the race in the long run and not the rabbit. A 20 percent average yearly return is exceptional for most professional money managers, yet many individual traders shoot for that every week or month. In my opinion, it is best to take guidance from the professionals who have a proven track record of winning and not new commodity traders who have a track record of losing in the commodity markets.
Past performance is not necessarily indicative of future results
