Feb 26, 2023 By: Dimitry Alriche Turnkey Trading Partners has assisted with hundreds of Commodity Trading Advisor (“CTA”) or Commodity Pool Operator (“CPO”) launches since our inception. If there is one thing that can destroy a trader’s business opportunity it is a large draw down early on. For this reason risk management is a critical aspect of trading that can make the difference between success and failure. While it’s impossible to eliminate risk entirely, there are several strategies that traders often use to manage risk effectively. In this article, we’ll discuss some of the key risk management strategies we have observed successful CTAs and CPOs implement when launching a trading business. Position Sizing Leverage is a stable of trading within the derivatives markets. Most traders really don’t understand how to properly work with the leverage concepts in the commodity interest sector. For this reason they often fail to properly position size. Proper position sizing involves determining the appropriate amount of capital to allocate to each trade based on the level of risk involved. Traders who use proper position sizing will not risk too much of their capital on any single trade. This can help to avoid significant losses. While the amount of risk per trade can vary by strategy and investor risk tolerance, most of the successful traders that Turnkey has assisted limit their risk exposure to no more than two percent of their nominal trade level per trade. Diversification Most traders today apply technical analysis to the markets they trade. They apply a systematic approach to how they model their strategies using computer software. For this type of trading, diversification of approach is one of the most fundamental risk management strategies available. By diversifying positions across commodity interest markets, traders can often find ways to reduce their exposure to any one particular risk factor. They also can find more opportunities for potential trades due to a broader range of market set ups their software can analyze. For example, a trader that applies this type of approach to one singular market or product can be negatively impacted by a singular news event. By finding ways to apply their same trading approach across different offered futures markets traders can minimize their overall strategy risk profile and improve their chances of generating consistent returns. Stop Losses and Spreads Emerging managers, especially those trading in Commodity Futures Trading Commission (“CFTC”), National Futures Association (“NFA”) regulated markets, tend to avoid using stop loss orders and spread techniques. While neither stop losses or spreads are a guarantee of loss prevention, both can be an essential risk management tool. CTAs and CPOs should always attempt to use tools that can help limit their losses in the event of an adverse market move. While it’s often true that today’s markets are more difficult to trade with stops in place; emerging traders trying to make a name for themselves can ill afford a substantial draw down during the early days of a trading advisor or fund launch. Ongoing Analysis Systematic traders, especially those who have developed automated software to assist them with trading, are often obsessively committed to their strategies. Ongoing analysis is essential for effective risk management in trading. Traders must continually monitor their positions and adjust their risk management strategies based on changing market conditions. By keeping up with market news and data as well as other technical trading information, traders can identify potential risks and opportunities and adjust their positions accordingly. Yes its true that traders should “trust the system” but never to a fault. Strategies are typically only successful for a short period of time. On average most new CTAs only survive 18 to 24 months. Many of these firms start off with strong results but they fade over time. While there are many factors that can cause a trading business to fail do not let stubbornness be one of them. While Turnkey does not profess to have all the answers, we have worked with many CTA and CPO fund launches over the years. Our team is in the unique position of being able to analyze what seems to work and what does not over time. If you or someone you know is considering starting a CFTC or NFA regulated trading business have them contact us via firstname.lastname@example.org or by phone (312) 324-0040 to speak with one of our CTA and CPO start-up consultants.