Key Takeaways
1. The 90% Failure Rate: It's Not the Markets, It's the Mistakes
The sad fact is that somewhere along the way the majority of traders make one or more critical mistakes in their trading, which cause their losses to exceed their winnings.
Unforgiving reality. Best estimates suggest that 90% of individuals who trade commodity futures lose money, and this figure might even be conservative. This staggering failure rate isn't primarily due to the inherent volatility of futures markets, which are often less volatile than stocks in raw percentage terms. Instead, it stems from common, identifiable mistakes made by traders themselves.
Zero-sum game. Unlike the stock market where many can profit from rising prices, futures trading is a "zero-sum" game; for every dollar gained, another is lost. This means a small minority of traders profit at the expense of the vast majority. Many are lured by the promise of easy money and excitement, but are utterly unprepared for the potential downside, akin to an amateur driving an Indy race car.
Learn from failures. This book focuses not on emulating the successful 10%, but on avoiding the pitfalls that claim the 90%. By understanding and actively sidestepping these common and costly mistakes, traders can significantly increase their chances of becoming consistently profitable. It's about learning "how not to be a bad trader" to clear the path to success.
2. Mistake #1: Trade Without a Plan, Plan to Fail
In futures trading, a surprisingly high percentage of traders enter the markets without the slightest idea as to how they plan to succeed in the long run.
Planning is paramount. Just as one would meticulously plan any new business venture, futures trading demands extensive preparation. Yet, many traders, seduced by the allure of quick riches, rush into the markets without a carefully thought-out trading plan. This lack of preparedness is a primary driver of the high failure rate.
High expectations. The desire for easy money often leads traders to focus on the "post-achievement" fantasy rather than the rigorous "achieving" process. Stories of traders turning small sums into millions, while inspiring, often overshadow the immense hard work, mistakes, and perseverance involved. Even legendary traders like Larry Williams and Michael Marcus experienced significant drawdowns and losses on their journey.
Your roadmap. A comprehensive trading plan serves as your roadmap, guiding you through market twists and turns. It requires addressing critical questions before trading, such as:
- How much capital to commit (minimum $10,000 recommended)
- Which markets to trade (diversify across at least three)
- Your ideal trading time frame and method (systematic vs. subjective)
- Clear entry and exit criteria for both profits and losses
3. Embrace the Four Cornerstones of Successful Trading
Constantly refer back to these four cornerstones when developing your trading plan.
Guiding principles. As you construct your trading plan, anchoring it to fundamental principles can provide a robust framework. These "Four Cornerstones of Successful Trading" are timeless truths that underpin long-term profitability and help build confidence in your approach.
Actionable tenets:
- Go With The Trend: Focus on identifying the current market trend rather than predicting future movements. Successful traders prioritize understanding "what is the trend right now?" over speculative forecasts.
- Cut Your Losses: This is arguably the most critical factor for long-term success. Accept that losing trades are inevitable and exit them quickly to preserve capital for future opportunities.
- Let Your Profits Run / Don’t Let The Big Winners Get Away: While seemingly contradictory, this means adhering to your objective profit-taking criteria. For trend-followers, this often means riding major trends for extended periods to offset numerous smaller losses.
Consistency is key. The effectiveness of these cornerstones lies in their consistent application. Developing a plan that incorporates these principles and then adhering to it, even when emotions or market noise suggest otherwise, is crucial. This disciplined approach helps navigate difficult periods and ensures you stay in the game long enough to capitalize on winning streaks.
4. Mistake #2: Leverage is a Double-Edged Sword – Don't Trade Too Big
When you boil it all down, it is this leverage which gives futures trading its great upside potential as well as its frightening downside risk.
The true risk. The common perception that futures markets are inherently more volatile than stocks is often misleading. The real differentiator, and the primary cause of problems for traders, is the extreme leverage involved. A small margin deposit allows control over a much larger contract value, leading to amplified gains and, more dangerously, amplified losses.
Ignorance is not bliss. Many traders enter futures without fully grasping the magnitude of leverage they are employing. They might put up $1 in margin, unknowingly controlling $33 worth of the underlying commodity. This lack of awareness, coupled with the misconception that the margin is the maximum possible loss, sets the stage for disaster, as futures trading involves unlimited risk.
Trading too big. The phrase "trading too big" refers to using more leverage than is prudent for your account size and risk tolerance. This exposes traders to sharp, potentially account-ending drawdowns. Understanding and managing this leverage through proper account sizing is paramount to survival, as a $750 margin on a $25,000 Soybean contract can quickly turn a small market move into a 100% loss of initial margin.
5. Master Account Sizing to Survive Inevitable Drawdowns
The ultimate goal of sizing an account is to limit any drawdowns in equity to a percentage amount which will not be so large that it causes you to stop trading.
Strategic balance. Proper "account sizing" is the antidote to excessive leverage, aiming to strike a balance between generating above-average returns and avoiding ruinous risk. The objective is to determine the optimal capital required for your chosen portfolio and trading approach, ensuring that inevitable drawdowns remain within a tolerable financial and emotional threshold.
Key factors for capital determination:
- Optimal f: A mathematical formula that suggests the capital amount to maximize profitability for a given system, based on its largest losing trade. While powerful, it doesn't account for drawdowns, making it risky for single-market application.
- Largest Overnight Gap: Acknowledging the potential for massive price gaps between market closes and opens (e.g., Crude Oil's $7,500/contract gap) is crucial for preparing for worst-case scenarios.
- Maximum Drawdown: The largest historical decline in equity from a peak to a trough for your system. This helps gauge the "normal" pain you might experience and whether you can emotionally endure it.
Realistic expectations. Combining these factors, along with considerations for diversification and avoiding over-optimized systems, allows for a more realistic estimation of capital requirements. Whether calculating an "aggressive," "conservative," or "optimum" account size, the goal is to prevent drawdowns from exceeding your "pain threshold" and forcing you out of the market prematurely.
6. Mistake #3: Risk Control is Non-Negotiable for Survival
The moral of the story: risk control in futures trading is NEVER optional.
Survival first. In futures trading, the ultimate goal is to make money, but the immediate priority is to survive. Risk control is not optional; it's the lifeline that keeps you in the game long enough to experience winning trades and profitable periods. The tragic story of Victor Neiderhoffer, a highly successful trader who lost $20 million in a single day by failing to cover naked put positions, starkly illustrates this point.
Downplaying risk. Many traders, fixated on upside potential, ignore or downplay downside risk, often believing in "easy money." This mindset is dangerous, as it runs counter to the reality of futures markets, where "fighting, fighting, fighting" a losing battle is often the quickest path to ruin. Instead, a healthy "fear" of losing large sums quickly is what keeps a trader's guard up.
Stay in the game. The long-term objective of risk control is to ensure you remain solvent and emotionally capable of trading. Short-term, it aims to reduce exposure and minimize daily volatility to a manageable level. Effective risk control prevents the emotional pressure of mounting losses from leading to drastic, costly mistakes like bailing out prematurely or doubling down recklessly.
7. Diversify Your Portfolio and Methods to Smooth the Ride
A lack of correlation between markets offers an opportunity for astute traders to minimize the fluctuations of the equity in their account.
Reduce choppiness. Diversification is a powerful risk control method that can significantly smooth out the equity curve of your trading account. By trading a portfolio of markets with low correlation (i.e., they don't move in lockstep), you reduce the risk of all your positions moving against you simultaneously.
Market diversification:
- Concentrated portfolio: Trading highly correlated markets (e.g., T-Bonds, 10-Year T-Notes, 5-Year T-Notes) means they often rise or fall together. While this can lead to big gains when right, it also means significant hits when wrong, resulting in sharp equity swings.
- Diversified portfolio: Trading uncorrelated markets (e.g., T-Bonds, Natural Gas, Japanese Yen) means they fluctuate based on different variables. When one market is in a drawdown, another might be trending strongly, offsetting losses and leading to a steadier equity climb.
Method and time frame diversification. Beyond markets, diversifying your trading methods and time frames can further stabilize returns. Combining a short-term trend-following system with a long-term one, or a trend-following approach with a counter-trend one, can ensure that while one method experiences a drawdown, another might be generating profits. This strategic combination helps maintain a smoother equity curve, making it easier to stick with your trading program.
8. Always Use Stop-Loss Orders to "Save Your Sorry Assets"
A wise old trader once said it best when he stated “the purpose of a stop-loss order is to save your sorry assets.”
Non-negotiable protection. A stop-loss order is a critical money-management tool designed to limit losses on individual trades. While some argue against them due to "stop running" or interference with systems, the author strongly advocates for their use, emphasizing that their primary purpose is not to enhance system performance or profitability, but simply to preserve capital.
Types of stops and their pitfalls:
- Placing in the market: This guarantees an exit if a certain price is hit, but doesn't guarantee the exact fill price, especially in fast-moving or limit-move markets. It can also lead to frustration when stops are "run" just before a market reverses.
- Mental stops: These are highly dangerous. They rely on a trader's ability to execute an exit at the worst possible emotional moment, often leading to hesitation and much larger losses when the trader "just knows" the market will turn around.
- No stops at all: This approach, while theoretically sound for some systems, exposes a trader to unlimited risk in reality, making them vulnerable to "that one bad trade" that can wipe out an account.
The ultimate benefit. Despite their drawbacks, placing stop-loss orders in the market offers one significant advantage: they ensure you exit a losing trade, preventing a small loss from becoming a catastrophic one. The goal is to stay in the game long enough to capitalize on winning approaches, and stops are the most reliable safeguard against being knocked out by huge, unexpected losses.
9. Mistake #4: Discipline Trumps Intelligence and Emotion
A lack of discipline is defined as failing to do what you should do in a given circumstance.
The hardest battle. Even the most meticulously prepared trader can fail due to a lack of discipline. This mistake occurs "in the line of fire," when fear, greed, or ego override a well-developed trading plan. It's the emotional "domino effect" that shifts focus from long-term objectives to immediate desires like "getting even" with the market.
The emotional triumvirate:
- Fear: Causes premature exits from trades, or stopping trading altogether during drawdowns, often right before a rebound.
- Greed: Leads to taking profits too early, missing big winners, or doubling up on positions to "make a killing."
- Ego: Makes cutting losses incredibly difficult, as it means admitting being "wrong," which goes against human nature.
The IQ obstacle. Surprisingly, high intelligence can be a hindrance. Intelligent people tend to over-analyze and try to "make sense" of unpredictable market movements. This analytical paralysis can prevent immediate, disciplined action when a plan dictates an exit, leading to mounting losses while the trader tries to rationalize the market's irrational behavior.
10. Don't Think, React: Follow Your Plan, Not Your Emotions
In futures trading—with a caveat to follow—you are often far better off reacting first and then thinking later.
Execute, then analyze. This contrarian advice is crucial for disciplined trading: if your well-thought-out plan dictates a specific action, execute it immediately. The specific chain of events or the "why" behind a market move that triggers your exit criteria is irrelevant in the moment. Analysis can come later, when the markets are closed and emotions are not clouding judgment.
Avoid traps:
- Live quotes for non-day traders: Constantly watching intraday price gyrations can tempt a position trader to deviate from their plan, leading to impulsive, costly decisions.
- System tinkering: Constantly adjusting your trading system during live trading, based on recent wins or losses, undermines confidence and prevents the system from performing as intended. Designate specific, scheduled times for system review and improvement.
The "Woulda, Shoulda, Coulda" cure. To combat the frustration of missed opportunities or premature exits, focus solely on the period between your trade entry (Point B) and exit (Point C). What happened before (Point A to B) or after (Point C to D) is irrelevant for current trading decisions. This mindset reduces emotional baggage and allows for objective system development during designated review periods.
11. Ask the Right Question: What Will You Do When Things Go Wrong?
In the long run what will make the biggest difference in your success or failure is not your prediction about what is going to happen in each situation, but how you react when things don’t go the way you expect them to.
Beyond prediction. Many traders obsess over predicting market direction, asking "what is the likelihood the market will move in the right direction?" While important, this question alone fosters false confidence. The truly critical question, often overlooked, is "what will I do if the market moves against me?"
Contingency is king. Your long-term survival hinges not on being right every time, but on how effectively you manage situations when you are wrong. A trader who dismisses downside risk with rationalizations like "I'm so sure the market is going up" is standing on the edge of a canyon without a parachute. This mindset is a recipe for disaster, as it prevents the development of a crucial fail-safe plan.
Prepare for the worst. Constantly asking "what is the worst-case scenario and what will I do if it unfolds?" forces proactive risk management. Having a clear, pre-determined plan for adverse market movements is the hallmark of a successful trader. Without such a contingency, you are vulnerable to the "one bad trade" that can wipe out years of hard-earned capital, as Victor Neiderhoffer's experience painfully demonstrated.
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