Coming from trading stocks/stock options primarily and trying to learn futures trading, one thing that has always concerned me about futures is the possibility of a market going limit-up or limit-down. Being locked limit-up or down against one’s position would prevent any stops from filling and results in a much greater loss than the risk management strategy (eg. entry to stop) allowed for. I can imagine it would be devastating in a small account.
Can you share your thoughts on the approach to lessen the impact of that scenario? How does one account for it in a trading system? Do we just chalk it up as the price of doing business?
Great question. Limit moves are not unique to US commodity futures. When I traded scrips (equities) in India, they too have what they call “upper circuit” and “lower circuit” which are effectively the same as limit moves in the US.
That said, limit moves occur when there is an extreme imbalance on one side of the market. The purpose of the stop in trading is to have as much information disseminate as possible, not necessarily to “limit” one’s daily losses or gains. The trading halt allows everyone to assess what’s happening.
I’ve been on both sides of limit moves. On the losing side, I was long LC and FC when the news of mad cow hit the tape. The commodities were locked limit down for 3 days I believe. Trading comes down to position sizing. Entries and Exits are not as important as position sizing. I stayed with the position through it all and I think I made some money. I have the temperament not to panic. Should have been a 911 operator…It all comes down to your breath.
One way to avoid unlimited losses is to trend trade using options or multiple option strategies. I’m not generally a seller of naked options. You can buy calls and buy puts and you’ll always know what your maximum loss is.
Some commodities, such as Cocoa, don’t have daily limit moves. I’ve been on both sides of some very wild swings in cocoa too. Each tick is $10 and a 100 point move is generally a big day. That’s about the equivalent of a $10 move in COMEX gold to put it in perspective. Gold or Cocoa, it’s how a commodity generally behaves that is compelling – what are it’s normal volatility and big standard deviation moves. Position size with these in mind.
I stress, it all comes down to position sizing…