Emotional stability is so very important when it comes to futures and options trading , or derivatives trading. In my twenty years experience in dealing with commodity futures, I have seen many corporations and individual traders in the edible oi industry who are tigers on physical trading, but pussy cats when it comes to futures trading.
They are not afraid to run huge losses in the cash market hoping for prices to move in their favour, but that is not the case when it comes to futures trading. The same tigers are so impatient when it comes to their stop loss getting hit in futures. They get so irritated and loose their mental stability, which is so pertinent in commodity futures trading.
The most important risk management strategy in futures trading is a stop loss. I have tried so many many times to drill this concept of stop loss into the minds of traders and needless to say only a handful have understood and embraced the concept so far. I think it is mostly due to their confidence in holding on to cash market positions that bleed out of the money only to come back in money subsequently. But, this holding period comes with huge amount of stress, hope and loss of health. Suddenly, god comes into the picture and deals are done with Lord Balaji the deity for prosperity to rescue out of the situation. After the cash position comes back in the money, a visit to Tirupathi is a must to thank god for his kindness and pay back the promised debt.
Unfortunately, none of this is possible in futures trading. Even god can’t save you, if you do not adhere to a stop loss. In cash markets, one holds on to a position hoping it will come back in favour , if the same strategy is adopted in derivatives too (Goom phirke wapas ayega), a very costly and dreadful experience will be in the offing. As the positions goes out of money, the intermediary will be breathing down the neck for mark to market margins and a cash flow implication for the accounts department to deal with reluctantly. So, stop loss is so sacrosanct for futures trading. And for that knowledge of technical analysis and other price studies will help a lot, rather than relying on vomited information( S&D’s) that is already known to the market. With all due respect, funda-mentals are needed, but one needs to know when not to use them, especially in an over-heated market condition like the CPO futures markets witnessed in the past few weeks. The inability to give back some money to the market by way of a stop loss, is the foundation for a huge loss staring at one’s face in the future. So, emotional stability comes, when one knows that stop losses might get triggered, but they protect as an insurance against price risk and therefore, not get carried away by market moves and stick to the trading plan as long as the stops are in place.
CPO prices shot up in BMD on the back changing fundamental picture overseas and in reaction to that domestic prices were on a roll in India and MCX prices reached a boiling point. From the time prices crossed 620 in MCX, it has been super overbought, a technical term used by chartists and price hunters, which obviously is not agreed by the industry and fundamental followers, as there has been a flurry of news flows re-affirming more upside. The important and basic principle of price studies and analysis is that all fundamental factors are already factored into the price and price itself is a lead indicator for direction.
We had recommended and initiated trading positions on the sell side as per technical analysis. It is like going counter to the trend. But with a stop loss, counter trend works well, because the risk is limited and one can take advantage of the subsequent downside correction. Time and Price have a close relationship like a husband and wife, but when price seeks happiness elsewhere and runs away, it only lasts for some time. Price is the husband and the wife is time. When price overshoots time, meaning if prices run away in a short period of time, it might not last long, because it has to come back into the relationship with time sooner or later. Which is what is also signified as overbought in technical parlance. Any sharp move in prices will exhaust itself sooner or later, like a trekker who reached the peak and no more upside to go, but only downside.
No one can predict a top, which is why there is a plan ‘B’ called stop loss. In case, you get it wrong you loose a tiny bit, which can be easily recovered over time. However, if you don’t adhere to a stop , then it could be very costly and the recovery will become the goal rather than making new profits. The industry was mostly on the buying side waiting for a correction, which was elusive and that added to stress levels for holders of short positions. Even though BMD futures corrected almost 100 points from their peak as expected, domestic prices were unmoved largely due to a weakening local currency and an expected rise in tariffs by the Customs.
As is always the case, it was a buy on rumor and sell on news that unfolded. Post the news, prices tanked lower. These patterns of market behaviour is captured in the price, which is then visible in a chart for the technical analyst to predict future price movement. Patterns are formed from habits by market participants and similar reactions to situations in the past. It is not easy to be sitting in a counter trend position and during the process an emotionally stable mind is a must, not to get carried away by market forces. A successful trader is the one who sees opportunity during adversity and vice versa. Most mistakes are committed either due to greed or fear. These are the two forces always in play in the minds of a trader that influences his/her trading decisions.
Only an emotionally stable person can reach greater heights in trading by moving with the flow of the markets and maintaining an equipoise, neither elated during success, nor dejected by failure.