Most people enter the arena of futures trading and really have no idea what they are getting into. They read a couple books, or a few magazine articles, and think they have found the ideal way to leave their day job for good.
Unfortunately, trading futures is like any other business … the best traders make the most money, and most other people are unprofitable.
One of the main reasons that most people are unprofitable is that they fall into the trap that futures trading should be easy. This is due mainly to many of the vendors and salesmen out there promoting the latest get rich quick scheme. Typically, these products involve day trading, because day trading is perceived to be less risky. The reason it is perceived to be less risky is because a trader does not hold a position over night, and therefore is not exposed to any news events that may adversely affect the markets. However, industry studies suggest that over 90% of these day traders are unprofitable.
One of the first things a prospective futures trader should do is conduct some significant research into how successful traders actually trade. A great place to start is the books written by Jack Schwager, which involve interviews with successful traders who make money in a wide variety of markets. Schwager has now written four of these books since 1988. The prospective trader should read these books and then conduct further research on the people who stand out most to them.
Another place to conduct some research is Autumngold.com. This is a service where commodity trading advisers pay a fee to list their trading programs available to individual investors. Here, you can find historical track records for many top CTAs, as well as a general description of their trading programs. Some of the descriptions may include systematic trend following, option writing, short term quantitative pattern recognition and a variety of other strategies.
Once you have discovered the trading strategy that stands out most, it is time to conduct some further research to learn how to employ a similar strategy to your own trading. Keep this in mind though … you need to also conduct a personal survey of your own situation to determine what type trading suits you and your personality. For instance, if you have a full time job during normal market hours, then day trading will not be suitable. On the other hand, if you are unable to accept the idea that trading losses are just the cost of doing business, and most of your trades will be losers, then a long term trend following approach may not work for you either.
After you figure out what style of trading suits you best, it's time to get some data and do some testing. It makes absolutely no sense to start trading futures with real money, and does not have a strong idea of how your trading strategy will perform over a long period of time. The only way to do this is to learn how to back-test your ideas on historical data.
Many people do not have the advanced programming skills necessary for developing an appropriate testing platform. However, there are some programs out there that are generally adequate for most traders.
Probably the most popular of these tools is TradeStation. This platform is also included with an online trading platform, which is convenient. The main drawback is that, once you learn the programming language, you really can only test one market at a time. This is problematic for traders, such as trend followers, who are looking for a solution to test strategies across an entire portfolio.
For TradeStation users, the answer to this problem is TradersStudio, which allows the user to import some TradeStation code, and allows for strategy testing across an entire portfolio.
More sophisticated traders who are not skilled programmers will step up to a product such as Mechanica, which offers more advanced risk management strategy. For the money manager handling many accounts, the high end product can also be utilized for trade execution across multiple accounts.
Many hedge fund managers and commodity trading advisers will hire their own programmers to create their own testing platforms. Programs such as TradeStation and TradersStudio are limited in that they employ continuous data series in futures markets that string together the individual contracts in ways that can skew testing results. For instance, it has been suggested that some reverse adjusted data series tend to have a long side bias.
One of the pitfalls of data testing is that many traders get caught up in seeking the holy grail, or the perfect trading system. The goal these traders have is to simply plug in the program, turn it on, and the profits start rolling in. In fact, many forex trading systems purport to do just that, and many prospects buy these products over and over again. Anyhow, individual traders should realize that there is no perfect trading system. They simply should seek a strategy that performs adequately over a long period of time.
After a prospective trader has connected this type of research, and has developed a strategy that they can call their own, they should seek ways to outperform the strategy using discretion. This generally comes with experience. A trader that can outperform their robust trading system will have a significant edge over other market participants, even professional money managers. Most commodity trading advisers are forced to trade on a systematic basis by their clients, who tend to be institutional investors seeking steady returns. They do not want any discretion implied, as this, in their minds, can lead to a potential blow up.
Gary Smith is one such trader. He developed a strategy for day trading stock index futures, and traded this strategy very successfully for years. Interestingly, he was never able to come up with a purely mechanical system that could outperform real trading results.
So, let's cover the necessary components of a successful futures trading program. First, the program must have a long term edge that gives it an advantage over most other participants in the futures markets. Trend follows strategies such as those employed by such notable traders as Bill Dunn, Campbell & Company, Winton Capital, Milburn and Ridgefield, etc., are examples of strategies that have a long term edge. Secondly, this trading edge must also have a risk management component that allows it to reserve capital during periods when the markets are not conducive to trading profits for the program being traded and to exploit the markets significantly when conditions are more favorable. Finally, the trader must have the knowledge, confidence and discipline to stick with a program over the long term, and enhance its ability to generate profits.
It took Gary Smith 18 years to become a profitable trader. Many other traders go through a similar educational process. However, if a prospective trader actually takes the time to conduct thorough research and learn from others mistakes, this learning curve can be dramatically shortened.