Belief 1: Being Both Long and Short the Market Is Not the Same as Being Neutral the Trade
In a seminar I conducted in San Diego regarding a few of the concepts laid out in this article, a man raised his hand and asked me, “If I am long a contract and short the same contract, aren’t the trades canceling out each other?”
The answer is a resounding “no!” When we use risk management strategies, one side is the insurance, and the other side is the trade. There are different levels of commitment, in both capital and price, so don’t get bogged down with this belief.
In much the same way that a corn farmer is not neutral in expecting the value of corn to go up, but still protects himself with options just in case the price falls, so does the sophisticated speculator manage his trading positions.
Belief 2: These Markets Were First Designed as Insurance Vehicles, Not to Be Speculated On
While it’s exciting to look smart at a cocktail party in knowing the direction a market is going-higher oil, weaker dollar, and ethanol expansion-knowing or presuming to know these things has little bearing on your ability to trade.
Look at the futures market as first being an insurance vehicle, and recognize that there is “daisy-chain effect” when it comes to trading based on the insurance aspect. The futures market protects the spot market; the options market protects the futures and/or spot market. Each alternative increases your leverage and diminishes your exposure to the underlying risk that the cash market may be experiencing.
So while the futures market leverage may be only 5% to 10% of the total value of the spot market, option contracts may be worth only 5% to 10% of the futures contract. Use this disparity to your advantage.
Belief 3: It Is Too Difficult to Understand/Learn
Earning money is not easy. Trading the markets, forex, futures or options, can be the most difficult activity to succeed at. While thousands of people get involved in the market year in and year out, 95% of them fail in their trading.
Knowing those odds, as a trader you are better off learning how to trade correctly from the outset. Utilizing the risk management techniques puts you head and shoulders above the 95% of traders who are simply picking a market side, the same way they would pick horses or roulette numbers.
Learn how to use these risk management techniques, and you will find yourself head and shoulders above the competition.
Belief 4: There Are Only Three Ways the Market Can Move: Up, Down, and Sideways
This is trading 101. Yet the concept is either forgotten or overlooked or assumed to mean that you must only trade one of the three possible scenarios to the best of your ability.
This is not the case. By picking “long or short,” you handicap your ability to trade by cutting yourself off from two thirds of your opportunities. As we learned in our technical analysis, by utilizing the 50-day moving average (MA), we can gain a tone for the overall market, but that doesn’t guarantee us the market will head in that direction.
With the proper risk management techniques, you can be both long and short, as well as trade sideways markets. You don’t have to pick-you just have to be prepared.
There will be various before-and-after examples to see how each one of the nine risk management techniques can help you increase your chances when you trade. Finally, we will pull it all together to help you have a more enjoyable trading experience.