from cerberus on April 18, 2006 at:
http://2cents.dailyreckoning.com/viewtopic.php?p=92417#92417


I would no more recommend futures as an investment vehicle to the average investor than I would junior mining shares, but these repeated claims of yours don't hold up well to scrutiny.

If you follow some simple rules (which the overwhelming majority of newbie futures traders ignore), then not only will you never get a margin call, you will greatly diminish your chances of getting "wiped out".

These are the rules:

1) Keep speculative capital separate from investment capital and keep it to a minimum of overall portfolio value. Following this rule alone will eliminate your chances of getting "wiped out" completely.

2) To ensure that you don't "wipe out" your speculative capital, limit the downside risks of any futures trade to no more than 10% of your capital for amounts under $100,000. For amounts between $100,000 and $500,000, this percentage should be reduced 1% for every additional $100,000 down to 6% for $500,000. For accounts $1,000,000 +, 5% or less per trade should be risked.

Risk of ruin can be calculated. In order to do so we need to make an assumption: let's say that your chance for a profit on any given trade is 55% -- or a .10 advantage (.55 to .45). If you can't do better than this over time, especially during a bull market, then you have no business as a speculator or trader of any kind (including speculating in mining stocks) and you are better off finding other ways to put your money to work... but we'll just use this number as a conservative assumption.

Let's also assume a $20,000 futures account in which risk is limited to no more than $2,000 per trade with an expected payoff of $2,000 per trade (net of average gain + average loss). Your chance of doubling your money in this scenario is .881 and your chance of ruin is .119. Trading indefinitely on this scale presents a chance of success of .866 and a chance of ruin of .134.

Too much risk for risk for rent money, savings, retirement, etc? Yes. Too much risk for a minor portion of a well-diversified portfolio? No.

And as the assumed chances of success on any given trade increase, the risk of ruin dramatically decreases along with a corresponding increase of success.

Let's say that you are able to pick 2 out of 3 winners over time with all the other assumptions above remaining the same. Certainly possible, though admittedly not the experience of your average futures trader who doesn't follow any of these rules. So a ~.30 advantage (.65 to .35). Under this scenario, both doubling your money and trading indefinitely have a .998 chance of success and a .002 chance of ruin.

3) Related to #2 above, have a stop loss system in place. The corollary to letting your winners run is to cut your losses short. Not only do newbies take their profits too early, they tend to let their losses run.

4) Be diversified. Diversify your risk among at least 3 or more not directly related markets. The more markets your trades are diversified across, the less volatile your portfolio and the better your chances of one of your trades being a "runner". It only takes one or two runners a year to more than make up for the expected losses which have been "cut short".

5) Be adequately capitalized. If you don't have at least $10,000 or even ideally $20,000 that you can earmark as speculative capital (i.e. not savings, not retirement money, not rent money), then you put yourself in a default position of breaking rule # 2 above.

6) Don't use maximum leverage. Between idle funds in your futures account and cash and equivalents held in other accounts, keep a large enough buffer to cover intraday volatility and limit moves.

Mileage will vary as to the size of the buffer and will depend on the particular markets you trade and your risk management strategy. If you never want a margin call, then that suggests a higher percentage of the funds in your futures account be kept idle. Of course, a margin call in and of itself is a meaningless event (it's the failure to meet it that presents an issue) and you could also do as Finster suggests and keep part of your buffer a wire transfer away earning interest in cash or equivalents.