A key attraction of trading futures markets is that the small trader has an opportunity of quickly turning a small amount of capital into a substantial sum of money. Leverage makes this possible, and the tool to harness leverage is money management strategy.
Leverage can only enhance strategies with positive Expectancy. It cannot turn a losing strategy into a winning one. Indeed, use of leverage will accelerate the ruin of a trader utilizing a strategy with negative Expectancy. For that reason the trader must be diligent about thoroughly back-testing the strategy to ensure positive Expectancy.
Leverage is a double edged sword and must be treated with respect. But there is little point in choosing futures as your investment vehicle if you are not prepared to use it (with due caution).
Money Management comes in several different forms, but the focus here is on the technique known as the fixed percentage method.
In this method, the trader calculates a fixed percentage of available capital prior to entering a trade, then divides this by the risk amount in the trade to determine how many contracts to enter.
For example, if capital is $8,000, the chosen fixed percentage is 5% ($400), and the risk per contract is estimated at $175, then you would trade 2 contracts ($175 into $400 goes 2 times).
The biggest decision you have to make is to choose the fixed percentage you are willing to risk on each trade. The larger the percentage, the greater the leverage. The greater the leverage, the greater the risk of ruin. Obviously, if you risk 20% of your capital on each trade, a run of 3 or 4 consecutive losses will decimate the account. However, the same bad run would not have a major impact if you risk just 1% per trade.
Professional money managers with large accounts usually choose 2.5% or less. Given a strategy with a positive expectancy, this keeps the risk of ruin very close to zero.
A trader with a small account will likely choose a higher percentage to accelerate earnings. Doing so introduces a significant risk of ruin which gets bigger as the percentage increases.