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Trading Lesson 3: If you know how to trade stocks, futures are a lot easier than you think

Every stock trader that I have trained starts off believing that futures and forex trading is mysterious.

“Fortune favors the prepared mind.” Louis Pasteur

There are many common characteristics that stock trading and futures trading share. First, off they both can bought and sold. Second, they have a ticker symbol that can be followed and monitored to show any change in price. Third, they both have electronic markets where they can trade side by side against open pit markets. While there are many other similarities, these stick out clearly.

The key difference between stocks and futures is leverage.

Jim Rogers, author of "Hot Commodities" and developer of the Rogers Commodity Index makes it a point to let investors and potential investors to his index understand that he trades "unleveraged" commodities. Why would he go to such great lengths to make such a distinction?

When it comes to stock investing leverage is rarely a concern. For every $1 an investor puts in he owns $1 in stock. Historical data has shown that stocks have earned on average 12% per year over the course of its life time. If a stock moves up or down 12% over the course of a year you have the opportunity to gain or lose .12 cents for every $1 you invest. So if things are going your way you could have $1.12, but if things go against you you could have .88 cents. Neither the gains nor the losses are so extreme as to change your life.

On the other hand futures, forex, and options have a different problem. While historically commodity and currency prices rarely fluctuate more than a 3-4% per year the every day investor rarely follows Jim Rogers' example of investing $1 for every $1 of commodities or currencies. If that were the case the average investor would find futures and forex far more manageable. Instead the average futures and forex trader puts up the minimum necessary which can easily be 1/10th, 1/20th, or 1/100th of the true the value of the commodity or currency.

Let's go back to our $1 example. If a given commodity or currency moves 4% over the course of a year, but your leverage is 20 times, basically you are putting up .5 cents to trade, that 4% move is actually an 80% move for you or against you. You have the opportunity to be up .80 cents or down .75 cents, based on investing with just .5 cents. That's a big difference from being up $1.04 or down to .96 cents by investing $1.

This allure to have potential gains of 80% instead of just 4% is what clouds the judgement of futures and forex investor into ignoring that they could also lose 80%. The need for fast profits leads them to focus more on how to beat the system as opposed to how to manipulate the system to their advantage.

Not manipulating the leverage properly is the bane of all stock traders that come to futures and forex trading. It's not the technical analysis, it's not whether or not you should day trade, swing trade or position trade, nor is it a matter of being able to understand fundamental analysis completely. The key is to find the amount of leverage you can live with and invest accordingly. If you can't handle potentially losing .80 cents for every $1 dollar you invest maybe 20 to 1 leverage is not for you. If you can't handle potentially losing .40 cents for every $1 dollar you invest maybe 10 to 1 leverage is not for you. Adjust the leverage accordingly by trading the proper number and type of contracts for your account size. By controlling your greed you will diminish your fear and you will find futures, forex, and options trading to be much more manageable than you ever expected.

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