Can Futures be Traded with Limited Risk?

Published by Sharekhan Education | May 19, 2023

By Prem Punjabi | Sharekhan Education

Futures trading can be a high-risk asset class, but it is possible to trade futures with limited risk with the right risk management tools and strategies.

Using a Stop-Loss Order

One of the most common risk management tools used in futures trading is the stop-loss order. It’s an order that is placed with a broker to sell a futures contract if it reaches a certain price. The stop-loss order can be set at a level where the trader is comfortable taking a loss. It can help limit losses if the market moves against the trader. However, it is important to note that stop-loss orders are not foolproof. And in volatile markets, the actual execution price may differ significantly from the stop-loss price.

Using Options

Another risk management tool used in futures trading is Options contracts. Options can be used in conjunction with futures contracts to limit risk. For example, a trader could buy a put option to protect against downside risk in a long futures position. If the market moves against the trader, the put option can be exercised. Which allows the trader to sell the underlying asset at a predetermined price. This can help limit losses in the future position.

Hedging: 

Hedging is a risk management technique used in futures trading. It is the practice of taking a position in the futures market, opposite to an existing position in another market. This can help limit risk by offsetting losses in one market with gains in another. For example, if a trader is long a certain commodity in the spot market, they could sell short a futures contract for the same commodity. If the spot price falls, the loss in the spot market position will be offset by the future position gain.

Position Sizing:

Position sizing is also an important risk management technique in futures trading. Proper position sizing can help limit risk by ensuring that traders do not risk more than they can afford to lose. Traders can use risk management formulas and techniques to determine the appropriate position size for their accounts and risk tolerance. For example, the 2% rule is a common position sizing technique where traders limit their risk to 2% of their trading account on any given trade.

Understanding Futures and Trading Plan

In addition to these risk management tools and strategies, it is important for traders to have a solid understanding of the futures market and to manage risk appropriately. This includes understanding the market fundamentals, technical analysis, and market sentiment. Traders should also have a well-defined trading plan that includes entry and exit rules, risk management rules, and profit targets. It is important to note that futures trading can be highly volatile and risky. Despite the use of risk management tools and strategies, there is always the potential for losses. Traders should be prepared to accept losses and should never risk more than they can afford to lose.

Technical analysis

Technical analysis is another valuable tool in futures trading. It involves analyzing price charts and using technical indicators to identify trends and potential trade setups. Technical analysis can help traders identify key support and resistance levels and potential entry and exit points. By using technical analysis, traders can better manage risk by entering trades at favorable levels and exiting trades when the market moves against them.

Discipline & Patience
It is also important for traders to be disciplined and patient when trading futures. Trading discipline means sticking to the trading plan and not deviating from it, even when emotions are high, or the market is volatile. Patience means waiting for the right trading opportunities and not forcing trades that do not fit with the trading plan. By being disciplined and patient, traders can better manage risk and increase their chances of success.

Conclusion

In conclusion, futures trading can be a high-risk endeavour but it is possible to trade futures with limited risk with the right risk management tools and strategies. Stop loss orders, options contracts, hedging, and position sizing are all tools that can help limit risk. Having a solid understanding of the futures market and managing risk appropriately is also important. This includes understanding the market fundamentals, technical analysis, and market sentiment. By having a well-defined trading plan and being disciplined and patient, traders can increase their chances of success and better manage risk.

This was about Trading in Futures with Limited Risk. To know more about such trading concepts, you may visit our website www.sharekhaneducation.com

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