A signal to buy or sell a commodity may be generated by a technical or chart-based study of historical data. Fundamental analysis, or a study of demand and supply forces influencing the price of a commodity, could also be used to generate trading signals. Important as signal generation is, it is not the focus of this book. The focus of this book is on the decision-making process that follows a signal.

First, the trader must decide whether or not to proceed with the signal. This is a particularly serious problem when two or more commodities are vying for limited funds in the account. Next, for every signal accepted, the trader must decide on the fraction of the trading capital that he or she is willing to risk. The goal is to maximize profits while protecting the bankroll against undue loss and overexposure, to ensure participation in future major moves. An obvious choice is to risk a fixed dollar amount every time. More simply, the trader might elect to trade an equal number of contracts of every commodity traded. However, the resulting allocation of capital is likely to be suboptimal.

For each signal pursued, the trader must determine the price that unequivocally confirms that the trade is not measuring up to expectations. This price is known as the stop-loss price, or simply the stop price. The dollar value of the difference between the entry price and the stop price defines the maximum permissible risk per contract. The risk capital allocated to the trade divided by the maximum permissible risk per contract determines the number of contracts to be traded.