Risk & Behaviour Before You Trade Commodities: Position Sizing, Stops & Discipline

A trade can be well analysed and still be badly managed.

In Chapter 11, we took a Crude Oil view and turned it into something more specific: an entry, a target and a level where the original reasoning would stop making sense.

But there is still one question left. If the trade goes wrong, how much are you actually prepared to lose?

That is where risk management begins. The quality of the idea still matters, but once money is involved, so do the size of the position, the behaviour of the instrument and what you do when the market stops cooperating with your plan.

Suppose you have decided that a Crude Oil trade becomes invalid if price moves ₹50 below your entry.

Using a simplified example, assume one lot represents 100 barrels. A ₹50 adverse move would therefore mean:

₹50 × 100 = ₹5,000 risk per lot

Now suppose ₹5,000 is also the maximum amount you are prepared to lose on that trade. One lot fits your limit. Two lots would turn the same idea into ₹10,000 of planned risk.

That is what position sizing does. It connects the trade on the chart with the money in your account.

Some traders use a fixed percentage of their trading capital to decide how much a single trade may lose, while others work with a fixed rupee amount. The exact rule can vary. What matters is that the position size comes from the amount you are prepared to lose and the distance to your stop, rather than how confident you happen to feel.

The stop-loss itself comes directly from the invalidation we discussed in Chapter 11. Your analysis tells you where the original idea stops making sense. The stop-loss turns that decision into an actual exit instruction.

That becomes important once the position is live, because a level that looked perfectly reasonable before entry can suddenly feel negotiable when the trade is losing money.

The target gives you the other side of the calculation. Suppose the stop is ₹50 away and the target is ₹150 away. You are risking ₹50 to potentially make ₹150, giving the trade a 1:3 risk/reward ratio.

The ratio does not tell you whether the trade will work, nor does an attractive ratio rescue a weak setup. It simply forces you to compare what you stand to lose with what you are trying to make before the trade begins.

All of those calculations assume the market gives you the prices you expect. Sometimes it does not.

Commodity prices can move sharply when supply expectations change, economic data surprises, weather conditions shift or geopolitical news hits the market. Higher volatility means the price can travel further in less time, which also means a position can move against you faster than expected.

A stop-loss helps define the exit, but it does not guarantee that you will always be filled at the exact stop price. If a major development occurs while the market is closed, the next available price may be significantly different. Even during market hours, a fast move or poor liquidity can mean the price at which you actually exit differs from the one you planned.

That is where gap risk and liquidity risk enter the picture.

Globally traded commodities add another layer because important developments do not follow your trading schedule. Crude Oil can react to events in major producing regions, Gold can move after a central-bank announcement and metals can respond to economic data released outside regular Indian equity-market hours.

Expiry matters too. Futures and options do not exist indefinitely, and carrying a position closer to expiry can bring changing liquidity and settlement or exercise rules into the trade.

The point is not that every trade will encounter one of these problems. It is that ₹5,000 of planned risk is a risk estimate, not a promise that the final loss can never exceed ₹5,000.

Chapter 8 separated two numbers that are particularly important here: capital required and actual exposure.

With futures, margin may be only a fraction of the value represented by the contract. But your profit and loss still respond to the full quantity in that contract.

That is leverage.

It also means that having enough margin available to open a futures position does not necessarily mean the position is appropriate for your account. A large adverse move can create substantial losses relative to the capital initially blocked, while mark-to-market losses can reduce available funds and potentially create a margin shortfall.

Options behave differently.

For an option buyer, the premium paid is the amount at risk while the position remains a long option. But knowing the maximum loss does not make every option trade a good one.

Time matters because an option can lose value as expiry approaches if the expected move does not arrive quickly enough. Strike selection matters too. A very low-priced option may look attractive simply because the rupee outlay is small, but it may also require a much larger move in the underlying before the trade works the way you expect.

An option seller has a very different risk profile. The seller receives the premium but takes on the corresponding obligation and generally needs margin to support the position. Losses can therefore be substantially larger than the premium received.

So choosing Futures or Options is not only about how much capital is needed to enter. You also need to understand how that particular position can lose money, how quickly that can happen and what expiry can do to it.

Most risk plans look sensible before the order is placed. The difficult part begins once the P&L starts moving.

Suppose your calculation says one lot fits the amount you are prepared to lose, but the setup looks unusually convincing, so you take three. That is oversizing. Nothing about the mathematics changed. Conviction simply overruled it.

Sharp commodity moves create another temptation. Crude Oil suddenly jumps on a geopolitical headline and the fear of missing the move takes over, so you enter without the setup you would normally require. Or you buy an option simply because the premium looks cheap.

Then the market moves against you.

The stop that made sense before entry gets pushed further away. Another lot is added to lower the average price. If the loss is eventually realised, the next trade is taken too quickly or too large in an attempt to recover the money.

Oversizing, FOMO, moving stop-losses, blind averaging and revenge trading may look like different mistakes, but they have something in common: the rules are being changed after the trade becomes emotionally uncomfortable.

That does not mean adding to a losing position is always wrong. Scaling into a position can be part of a planned strategy if the levels, size and total risk were decided beforehand. Blind averaging is different because the extra risk appears only after the original trade has already gone against you.

Available margin can create the same trap. Seeing unused buying power in the account can feel like permission to take a bigger position. It is not.

Sometimes risk management means never entering the trade at all.

Your fundamental view and the chart may disagree. Liquidity may be poor. The contract may be nearing expiry. A major announcement may be minutes away. Or perhaps the only reason you want to enter is that the market is moving quickly and watching from the sidelines feels uncomfortable.

None of those situations requires you to trade.

There will always be another chart, another contract and another opportunity. Protecting capital when the trade does not make sense is just as much a part of trading as knowing where to enter when it does.

Before placing the order, you should be able to answer:

• What commodity am I trading?
• What is moving it?
• Am I trading Futures or Options?
• Which contract am I using, and when does it expire?
• What is the lot size?
• How much capital is required?
• What is my actual exposure?
• Why am I entering?
• What would prove my view wrong?
• Where is my stop-loss and what is my target?
• What is the maximum amount I am prepared to lose?
• Is there any event, liquidity or expiry risk I need to account for?

If those answers are unclear, the trade probably is too.

Part 1 began with a much simpler question: what exactly is a commodity?

From there, we moved through how these markets work, what trades inside them, how Futures and Options behave, how much capital they require, what moves commodity prices and how a market view becomes a structured trade.

Risk is what holds all of that together.

A good market view can still become a bad trade if the position is too large, the risk is undefined or the plan disappears the moment the market moves against you. Before you execute, you should know not only why you want the trade, but what it is allowed to cost you if you are wrong.

• Position sizing connects the amount you are prepared to lose with the stop-loss distance and the quantity represented by the contract.
• A stop-loss turns the invalidation level from your trade analysis into an actual exit instruction, while risk/reward compares the planned loss with the potential gain.
• Volatility, gaps, liquidity, global events and expiry can make the actual outcome different from the neat risk calculation made before entry.
• Futures and Options carry different risks. Futures can create large exposure through leverage, while option buyers and sellers face different premium, expiry and payoff risks.
• Oversizing, FOMO, blind averaging, moving stops and revenge trading can undo a good trade plan, while choosing not to trade can itself be a valid risk decision.