Learn the risk involved in Systems Trading

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When it comes to commodity trading systems, besides building a good methodology with a sophisticated logic that goes into generating the dynamic portfolio, you must integrate other factors that could have an impact on the performance of your trading.  Specifically, the trading algorithms should constantly monitor and manage 4 different measures of risk exposure on any given trade.

• Risk per Trade-The first and most obvious level of risk that is evaluated is the individual risk in the trade itself. This risk will always be limited to a very small percentage of the account size. Generally speaking the systems should attempt not to risk more than 2% of equity per trade. This helps minimize the risk of any single trade to the entire portfolio.

Past performance is not necessarily indicative of future results. The risk of substantial loss exists in futures trading.

• Sector Risk -What sector risk does is to evaluate the current positions in the portfolio to see if new trades being presented are too highly correlated to current positions. .  What this means is that if you are already long a crude oil position that has a risk of 3%-5% of the portfolio then any new trades in related markets like heating oil or unleaded gasoline should be rejected. The reason for this is because some of the biggest and most severe losses tend to come from times when a portfolio is overly exposed to a lot of highly correlated items and they all move against the portfolio at once. This risk is greatly mitigated by having stringent sector risk controls in place.

• “Portfolio Heat” – Portfolio heat is the amount of money your portfolio would lose if ALL positions where stopped out at the same time.

Portfolio heat is critically important because during extreme periods correlation seems to come close to 100% on everything. Basically it seems as though everything that was going up starts going down and everything that was going down starts going up. These are periods where in spite of being diversified among sectors you can still see events (albeit uncommon) where you get stopped out of most if not all of what you’re in.

• Equity Risk. Finally, a system should keep track of and manage changing open trade equity risk. This comes into play during winning periods. For example, assume you started a crude oil trade with $2,000 in risk, however the market has gone sharply in your favor and the stop did not rise as fast as the market did and now the stop is $4,000 away. This means that without adding a single new position your risk just doubled! Furthermore imagine this happened on multiple trades at once. You could end up in a position where your risk has doubled or tripled without adding any new trades. In our opinion this is why some of the biggest drawdowns come after some of the biggest run-ups.

If you are looking get more information in this area, please go to the following page:

http://www.optimusfutures.com/commodity-futures-trading-system.htm