Volatility in Commodity Market
The commodity markets continue to experience volatility, and before you start to risk capital in that sector, you should have a robust risk management plan in place. The volatility you might experience while trading oil could rise as high as 50%. Meanwhile, natural gas volatility can reach levels near 80%. This can be compared to volatility of 10% for most major currency pairs.
What is Risk Management
Risk Management is the process of determining your risk of loss prior to executing your trade. You may want to avoid a carefree attitude toward trading and make sure that you pre-determine where you are planning to take profit and where you are expected to stop out of your position. A great way to handle your risk management is to embed it into your trading strategy. You can monitor your oil and gas trading on a commodity trading app.
The first step should be to define how much you are willing to risk on a specific trading strategy. For example, you might have $1,000 portfolio and you may want to use $500 for trend following. Of that $500, you might be willing to risk 20% or $100 dollars on a trend following strategy. This would mean that if you lose more than $100, you terminate the strategy. Going in with an idea that you are going to turn your $1,000 into $10,000 immediately without a plan will likely lead to disappointment.
Risk Management on Trades
Each trade that you place should also include a specific risk management measure. You may want to execute a trade with an idea of where you plan to take profit and where you are expecting to stop out with a loss. You can start with determining how much you can afford to lose and then use that loss calculation to determine your gain. This defines your risk versus reward profit.
Your reward versus risk is generally predicated on the strategy you choose. For example, a trend following strategy generally makes more on each trade then it loses, but you will lose on more trades than you win. Since most markets only trend a third of the time, it is desirable to cash in when it happens. Here is a simple calculation; if you win $2 for every $1 that you lose, you can afford to win only 33% of the time and still break even. For example, if you win $2 on 3-trades (a total of $6) and you lose $1 on 6-trades (total of $6), you break even. Alternatively, if you win only $1 for every $2 you lose you need to win 66% of the time to break even.
Since oil and gas volatility is very high relative to indices and currencies, you may want to make sure you have a sound risk management plan prior to risking your hard-earned capital. You might want to employ a sound risk management approach at a strategy level and on each individual trade. Prior to risking your capital, you should have a clear idea of where you will take your profits and where you will schedule a stop loss. It is advisable to embed your risk management into your trading strategy before you execute a trade.
This is a guest post from one of the overseas contributor of IndianPowerSector.com