When you walk into the casino there are not only different games where you must employ different strategies, but there are also different Limit tables, so that people with differing chip stacks can find the game they want to play.
In the Futures Game it works exactly the same way.
Your starting chip stack will determine the table Limit you play at, and the variance in game will be driven by the different instruments you choose to trade across different sectors.
We cover and actively trade in Stock Index, Metals, Energy, Grains, Softs, Currencies, and Rates Futures. All of the individual future contacts not only have separate specifications and margin requirements, but they really are different animals. Natural Gas trades very different than a 30 year Treasury Bond, and liquidity is much narrower when trading Coffee than when trading the S&P.
We have a Specifications tab in the Alchymist Portal which will give you the high level details on each contract as well as a web link to the exchanges so you can learn as much as you can about the instrument you intend to trade. What will really be required though is daily observation, and study of history so you can ascertain the behavior and personality of each instrument.
Just like a Poker player, you have to see and play thousands of hands to improve your play. With the historical lookback capability across the Alchymist reports and data tables, you will be able to accelerate your learning curve - Provided you are committed and put in the required time.
Outside of the variation across contracts, the primary driver of the type of game you play will be your starting chip stack.
In terms of Casino references, your choices of game can either be Poker or Craps.
We will use the same philosophy regarding trade selection, odds, risk management, and bankroll management regardless of which game you choose. The betting techniques differ in order to achieve our mandatory requirement of managing risk, and we will now delve into this discussion.
The 3 Point Shot
The 3 point shot has revolutionized the game of basketball. Your reward for being a marksman capable of shooting the ball from distance is that you earn one additional point. As the game has evolved and players have worked on their shooting, it's now not uncommon to see teams hoisting 30 threes per game. Something that would have been shunned a decade ago, preferring for higher percentage shots closer to the basket, is now encouraged in a run and gun league.
So are coaches out of their mind or is there a method to their madness? The answer lies with the implied odds and increased reward you get for hitting the three. Simply stated, if you shoot 30 three point shots a game, but only make 33% of them, you score 30 points. If you were to shoot 50% from 2 point range over those 30 shots, you also score 30 points. The thing is, perimeter shooters rarely shoot 50% from the field - They are mid or low 40% shooters. Now you can see where the odds come in and the benefit of the 3 point shot.
A 33% 3pt shooter is a more efficient scorer then the 45% 2 point shooter, so coaches are opting for the three.
It is a similar concept that pertains to trading, and how you are attempting to score. If you read trading books, blogs or follow traders on blogs, these days everyone says you need to have a risk reward of 3-1 before placing a trade. So in our chip stack management example, if you are betting 2.5% per bet, then your target profit is 3 times that or 7.5%.
Your success as a trader is going to depend on 2 things then: 1) Your Winning % 2) Your Risk/Reward Ratio across all of your bets.
If your Risk Reward is 3-1, then you only have to shoot a bit over 35% to have a money making platform. There are a million variations you can make on this, but ultimately the combination of these 2 inputs must get you above zero or you have a losing system.
The key point to highlight here is that your winning percentage can be well below the 50% mark, yet provided your risk/reward % is greater than 1, you can still be a winner. This is a concept most people struggle with because they bring their elementary school teacher with them to the trading arena. They think they need to score High marks of 85% or better, and they have to be right - if not, then mommy will yell at them and they feel shame.
Because they have to be right, they can't take a small loss, so they end up holding onto losing trades and busting out in short order. Our failed education system sabotaging a unsuspecting trader.
Instead of bringing your scolding teacher to the arena, may I suggest you invite the Hick from French Lick instead? - You might learn something about betting from him.
A 37.6% 3-pt Shooter??
Larry Legend. 3 Time NBA Champ, 2 Time Finals MVP, and 3 Time 3pt Contest Champion. He's widely regarded as one of the greatest 3pt marksmen of all time. So when we look at his amazing career statistics, you might be surprised to see his career 3pt shooting percentage - 37.6%... Wow?! - Really? that's it? What about other great Marksmen like Reggie Miller or Ray Allen? They come in at 39.5% and 40% respectively. Of course they weren't beating Magic and Showtime in the Finals en route to 3 NBA titles, but this isn't the point.
The point is, if Larry can have a Hall of Fame career shooting the 3 a few % points under 40%, then so can you.
If your win rate is 40%, but your gains are 1.5 to 1 over losses, then you are break-even. If you get that up to 2-1 you are making nice money, even while being wrong 6 out of 10 times. Remember, booking a loss on a trade is just like missing a 3 point shot... It's just got you one step closer to your next make!
Over a season, and career, your place betting and profit booking strategy will make you a winner, provided you give yourself enough looks at the basket.
This concept of Risk/Reward and winners being greater than losers has to be your place betting strategy for swing trades.
Swing trading is taking a position in Futures from a few days to up to a few months. There is a favorable setup you see and your chip stack is allowing you to make incremental bets that allow the wiggle room to wait. Going back to our actuarial tables on Gold - We said that Gold's 70th percentile move was $22 dollars or $2,200 per contract.
In order to adhere to your 2.5% per bet risk strategy, you'd have to have $100k in equity in your account in order to withstand the high likelihood of a $22 move against your position, and this is a key point I want to highlight.
If you allowed a $22 move against you with a 20k starting chip stack, this would be a 10% starting bet. Once you experience a losing streak of 4-5 in a row, which is inevitable, you would have suffered a devastating 50% drawdown. You'd now need to double up just to get back to even, and I hate to tell you, not many traders are out there earning 100% returns on their capital.
You could try to play with much tighter dollar stops, so say only a $5 move in gold against you, but in this day and age of the machines, I don't see this as a winning strategy. The price of gold will whip around $5 every 5 seconds, and by the time you key in your sell order, you will lose 5 more.
I want you to set up trades in that 20-40 day time window, where we know the odds of what range price tends to trade. In the 70-80th percentile zone is what I want you to focus on and try to take a piece of. So if Gold Moves $22, 70% of the time over a 20 trading day interval, we'd be happy capturing half of that on a regular basis.
I can hear the whining already... "But I don't have a 100 to trade?!?". The answer to this, is that you have to play a different table game. Instead of stepping to the No Limit Hold Em tables, where you can be easily overwhelmed by players with a larger chip stack, you have to head on down to the craps table.
The game of craps is a Dice game - Without getting into all the nuances, we will discuss the house edge.
In this game, your goal is to roll any place number (4,5,6,8,9,10) before you roll a 7. If you roll seven, the house wins, and takes all bets that are on the table - this is called "seven out". So why does the house win on seven, while you lose? Because out of the 36 combinations one could roll using 2 dice, the seven can be made 6 ways, while every other number can be made fewer ways than that. According to the rules of the game, they get the house edge.
If we look at the next number with the highest number of combinations, it's the 8 & 6, which can be made 5 ways. For example when rolling a 6 you could roll: 3+3 - 4+2 - 2+4 - 5+1 - 1+5 ).
So if you are place betting the 6, then the house has a 6-5 edge on you. But do they pay you 6-5 when you hit? Of course not - to further increase their odds when you win , they only pay you 7-6. So we can see that the house has a distinctive edge here - how can you compete? There are 2 things you need to do.
1) As the 7 has you dominated from a odds perspective, we need to place 2 numbers at the outset. You place both the 6 and the 8. Now, rather then being at a 5-6 disadvantage, you actually are almost 2-1 favorite over the house. (10 -6 odds in your favor - which is: 5 ways to make the 6, + 5 ways to make the 8, vs 6 ways for the house to win via the 7)
As noted above, the house pays you 7-6 for these numbers, which means your dollar outlay is 6+6 or $12 for betting the 6+8 at a $5 limit table, but if you hit you only collect $7. So using this betting technique you are risking 12 to make 7. This does run contrary to our stated betting strategy on swing betting and earning multiples of your risk, but in craps you have to do it in order to overtake the built in house odds.
In the futures game you will employ a similar strategy. You will bet only when odds favor it, but you will do it by going long or short options that are 60-90 days from maturity. This will allow you to control your risk, as maximum loss is the value of the contract. The difference here however, is that we have to take quick hitters and not look for multiples of our risk outlay. If you make 20% or more on your option, you cash that in & talk later.
2) Regression Betting - This is a gambling technique whereby you bet 2 units on the opening bet when you have the 10-6 odds advantage as discussed above - Then, as soon as you hit, you pocket the winnings, and reduce your bet to one unit. This way, even if you 7 out on the next roll, you would have had a profitable series. The concept being that you bank some profit immediately, while still leaving some chips at risk so that you can participate in a trend if one develops. If it does, you continue to bet in a way that utilizes the "house money" or gambling winnings to finance additional bets.
Buying Options - The Futures Version of the Craps Game
If your starting bankroll is $20k, and you are practicing sound risk management techniques, then you only want to risk 2.5% per bet - that would be $500 in this case. Because Futures contracts are so leveraged, it will be extremely difficult for you to adhere to this loss level. The only way to ensure this small loss, is by buying either call or put options. Remember, a call gives you the right to buy the underlying, and a put gives you the right to sell the underlying at a specific price and by a specific date.
The maximum loss of any option you buy is the purchase price of the option. This makes them a amazing vehicle to trade for controlling one's risk - which of course is your number one job.
Your betting strategy for this chip stack size should be as follows:
1) Look for out of the money options whose dollar price costs you the max allowable bet, or in this case $500.
2) As the options are out of the money, meaning either greater or less than where the underlying future is trading today, then the "Delta" or amount the option moves,will be considerably less than what the underlying future moves. Again, by design, using this betting instrument is reducing your risk.
3) You will buy the option only when the odds favor you - You'll know this via the tools in the Alchymist Platform.
4) Buy 2 units at the outset (so 2.5% *2 or 5% outlay)
5) You utilize regression betting, by selling 1 option as soon as you are in the money, and then let the other option ride. This allows us to take advantage of a trending move if it develops.
A key point to remember is that just because your outlay is 2.5 - 5% this doesn't mean that you have to lose all of it.
Remember that options have varying components of price, such as time value and volatility, in addition to the Delta. So if you buy an option which has 90 days to maturity, even if you are completely wrong directionally, the option will still have value due to the time component as well as the optionality it provides traders to participate or hedge price moves. It's insurance right? So someone will be out there willing to buy that policy from you.
You will be buying and selling these options based on specific price pivot points on the underlying future.
So lets take Wheat for example. If your analysis and system tell you that when Wheat crosses 420 it's a buy, you can purchase the 450 call option for 7 points or $350. If wheat reverse immediately and closes below 420, you can close the position and book a small loss or small percentage of the total value of the option. You may be getting in and out of the position multiple times (for small losses) before it finally hits and we are able to harvest our gains.
If you are new to options and this discussion is somewhat confusing, please don't worry. I assure you this is very simple math, and once you spend some time viewing option prices and the Greeks, as well as following some live examples, this will all start to make sense to you.