With energy, and oil prices in particular, being so much in the news over the last year or so it seems that a lot of people are interested in trading in the energy markets. What amazes me as I come into contact with these people through the Energy Trader Team and Energy Trade Alerts that oilprice.com offers, though, is how many of them wish to do so without using futures.
There are ways of doing that, of course. The leveraged ETFs DWTI (bearish) and UWTI (bullish) for U.S. oil along with DGAZ (bearish) and UGAZ (bullish) for U.S. natural gas can be used in a regular stock trading account and are great for playing multi-day trends in those markets, but they don’t offer anything like the leverage obtainable through the futures market. For many, though, it is that leverage that scares them. They have been told that leveraged trades are dangerous, and futures especially so.
The thing is, though, if you use futures in a limited, somewhat controlled manner and understand how to control risk they can be no more dangerous than the stock market. The first thing to understand, as least as a newcomer to futures, is that they are best used for short term trading. I rarely run a futures position overnight, preferring to use them as day trading instruments, because they are traded when the official markets are closed, but after hours trading is extremely thin. That leads to some exaggerated moves overnight and at weekends and often bad fills for stop loss orders.
Those stop losses are essential to controlling risk if you are to trade futures. I generally trade the E-Mini WTI contracts (/QM), which move two and a half cents at a time, with each tick representing $12.50 profit or loss. My trades are usually set up with a stop loss around 8 ticks (20 cents on the price of WTI) away, minimizing losses to around $100 per contract. The margin requirement for the trade is $1,870 per contract, so I stand to lose just over 5 percent if the trade goes against me. Given that I never employ more than 20 percent of trading capital on any one trade that limits losses to around 1 percent of my account. Profit targets, on the other hand, are around twice that.
Of course, there is no risk control method that is perfect. Stop loss orders are executed at the next available price after your level trades, not necessarily at that price. That is why leaving trades with such orders attached overnight, when markets are thin, is generally not a good idea. In my experience,…