Position Sizing, Risk & Money Management Strategies For Futures Trading

Trading in equity/commodity/currency can be supremely rewarding, if you have got your trading strategy right. Now let’s say you are consistently making Rs. 10,000 profit per month using 1 Lot of Nifty, by day trading/swing trading/position trading.

What do you do next?

Start trading 2 lots? If yes, when do you scale up to 3 lots? After 1 month? or 2 months? If 2 months, why 2 months, and why not after 3 months?

When do you trade 10 lots? 100 lots? When do you stop? How does one increase the lot size in a logical way, without the risk of a blowup or a massive drawdown?

STEP 1.

First, calculate your overall networth. Your networth is the amount of money & asset you have, minus your liabilities. Example: You have a networth of Rs. 10 Lacs if you have the following -

Financial Assets :

Cash in savings account: Rs. 1,00,000

Fixed Deposits & Provident fund: Rs. 3,00,000

Stocks or Equity mutual funds: Rs. 2,00,000

Margin Cash with broker: Rs. 1,00,000

Total: Rs. 7,00,000

Physical Assets :

Car: Rs. 6,00,000 (Use carwale.com used car evaluation to check the approximate current value of your car)

Wife’s Gold Jewellery: Rs. 2,00,000 (approximate weight in gms x 0.9 x Gold price per gram)

Total: Rs. 8,00,000

Financial Liabilities :

Car Loan Outstanding: Rs. 5,00,000

So your total networth is Financial assets + physical assets — financial liabilities = 7 Lacs + 8 Lacs — 5 Lacs = Rs. 10 Lacs.

Maintain an Excel sheet of your networth, and update the networth daily. Prices of your funds in equities changes everyday. Valuation of Gold you own (in jewellery form) changes everyday. You earn interest everyday. You spend money on something or the other everyday.

Basically, your networth changes everyday. And its important to track the changes using Excel. Use Moneycontrol.com’s Portfolio for tracking your networth.

STEP 2 :

Link your open Futures position to your Networth. That is, back your leveraged Futures positions with real assets (financial & physical). That way, you don’t have leveraged positions at all — all your Futures positions are backed by real money. You are essentially taking zero leverage, while taking 90% leverage! Let me explain with an example -

Let’s say you are trading in Nifty.

Nifty Spot value: 6000

Minimum Lot size: 50

1 Lot Nifty Future exposure value: 50 x 6000 = Rs. 300,000

Since you are linking your Futures positions with your networth (Rs. 10 Lacs), you can now trade in maximum of 3 Lots of Nifty (total exposure value: Rs. 9 Lacs), and perhaps trade in 2 Lots of USDINR (Exposure value = 2 x 60,000 = Rs. 1.2 Lacs)

If you have a networth of Rs. 3 Lacs, trade in 1 Lot of nifty

If you have a networth of Rs. 1 Lac, trade in 4 lots of GOLDGUINEA (worth 30k each) or 2 Lots of SILVERMIC (worth 50K each).

STEP 3.

Now increase or decrease your position size in futures based on your networth.

If your networth has become Rs. 12 Lacs because of trading profits/increase in share prices/salary income or bonus etc, add positions in futures equivalent to the gain (Rs. 2 Lacs). If your networth has become Rs. 9 Lacs because of trading losses/decrease in share prices etc, remove positions worth Rs. 1 Lac (USDINR contracts for example).

This way, you automatically increase your position size when you are doing well financially. And you automatically reduce your futures position size when you are not doing well.

By following this religiously, you adopt the money/risk management strategy that is recommended by all professional traders -> the anti-martingale strategy. You increase your position size when you are winning and you reduce your position size when you are losing .

Disadvantages :

1) Even if you are making trading profits, you might have to reduce your position sizing, especially since your networth consists of Gold/equities, that are volatile.

Solution. If you are making good profits in trading, get out of equities. Invest that money in safe debt Mutual fund or fixed deposit.

2) It’s a very conservative strategy.

Solution. Take positions in futures worth X times your networth. If your networth is Rs. 3 Lacs, make it a rule to take positions worth 1.5 times your networth. This way, you will be able to take positions in futures worth Rs. 4.5 Lacs.

However, I wouldn’t recommend the above. Because, soon greed will takeover and you might start taking futures positions worth 2x, 3x times your networth!

I’m personally following this strategy because I know I will never blowup my account. This is one of the strategies you can follow — if your intention is to trade for 10 years, 20 years or more.