Setting A Risk Limit

If you’ve read anything about futures trading, you’ve probably already gathered that it’s a risky business. Volatile markets can be risky at the best of times, but when leverage is factored in it becomes a whole different ball game. As a result, managing your risk is as big a concern with futures trading as maximising your profits, and the need to control risk exposure at all times is central to any successful trading plan.

One of the easiest ways in which you can control your risk is to set an overall risk limit, applicable to each transaction, which establishes the ceiling amount of risk you’re willing to take on board on a per-trade basis. Establishing, setting and sticking to a risk limit, in the same way as a profit take, can help breed a degree of consistency into your trading that will pay dividends in helping ensure you’re trading in an aggregate profitable position.

What Is A Risk Limit

A risk limit is a notional percentage limit over which you will back out of a position. It sets the point at which you are no longer willing to fund a position in order to keep it open, and thereby serves to cap the potential risks you would otherwise face. Given the nature of the futures markets, there are no obvious cut out points or limits to your liability. A losing position that is left to run will run on in perpetuity, racking up massive losses indefinitely (or until the broker forces you to pay up.) As a result, identifying measures and practices you can deploy to limit risk and reduce the downside exposure is imperative in defending your capital and protecting on the downside risks.

Calculating Your Risk Limit

The risk limit you choose to trade with is a matter or personal judgement and appetite risk. Depending on just how risky you’re prepared to go, your risk limit may be higher or lower on a per transaction basis. The central factors you need to consider are how much you can afford to lose on an individual position in percentage terms, and the effect of one or more maximum losses on future account performance. While two separate 1% losses may not individually be too damaging, the impact that can have on your daily performance targets can be much larger, so these are all issues you need to weigh up in order to determine what your risk limit will be. This will give you an idea of how much risk you can bear across your portfolio, and help you to form opinions about the best transactions to enter and trade.

Controlling risk in futures trading is an integral part of the successful trading picture. Without the ability to control and cover the risks that present themselves in the course of daily trading it can be difficult to make an overall profit, and even more practically tricky to keep a handle on the risks and rewards you’re facing across different parts of your account. By setting a risk limit on a per transaction basis and sticking to that, you should give yourself the best chance of yielding a profit on the aggregate over time, which is ultimately the most effective and reliable way to derive a profit from trading the futures markets.

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