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Concept: Commodity Futures Trading
SPARE LITTLE TIME TO READ THIS, LENGTHY BUT REALLY USEFUL!
Commodity futures trading is an often-overlooked investment
arena. There are a number of reasons for this. First of all, it’s simply
not an investment that’s publicly touted as widely as stock trading
and other more common investments. Commodity futures trading is different from stock trading, so it does require traders to learn
how to handle investments in a different type of market. Also, many investors have been scared away from commodity trading by
horror stories from investors who lost huge sums in the commodity
markets. The truth is that while commodity trading is a higher risk
venture than conservative fixed-income investments or traditional
stock trading, it is nonetheless a market in which it is possible to
generate high returns that more than justify the additional risk.
Understanding Futures Contracts
Commodity futures are traded in the form of contracts of a
standardized size (for example, 5,000 bushels of wheat) that expire
in different months. This is obviously different from stock shares
that have no expiration date and can be held indefinitely. Futures
for a given commodity can usually be traded as far ahead in time as
two to three years, however, the vast majority of trading nearly
always occurs in the contract with the closest expiration date,
known as the “front month”.
Futures prices are more subject to sudden, volatile price changes
than stocks typically are. A stock that has a long history of steady
price appreciation or dividend payouts is likely to continue that
trend. But with commodity futures, a downtrend in price can
change to an uptrend literally overnight due to factors such as an
unexpected freeze or drought during growing season.
Futures contracts are divided into five main categories:
Agricultural futures, such as corn, wheat, orange juice, and cocoa
Livestock futures, such as lean hogs and live cattle
Energy futures, such as oil, heating oil, and natural gas
Metals futures, such as gold, silver, and copper
Financial futures, such as Treasury bonds, stock indexes, and
Fundamental and Technical Analysis in Commodity Trading
Fundamental forces of supply and demand are what ultimately
move commodity prices. Therefore, there is a high percentage of commodity traders who use fundamental analysis to attempt to
predict futures prices. Commodity traders glean information on the
commodity markets from sources such as financial newspapers,
research information from brokers, and government reports.
Advisory services that traders can subscribe to are an important
source of information. Some advisory services feature their own
expert meteorologists offering weather forecasts for important
crop-growing regions, and send their own investigators out to
make personal estimates of eventual expected crop sizes.
Despite the fact that genuine supply and demand factors are what
drive commodity prices, technical trading is still enormously
popular among commodity traders. In fact, many of the most wellknown technical indicators that are applied across many other
investing markets, such as stocks and forex, were first developed
by commodity traders.
Advantages of Commodity Trading
Unlike stock trading or investing in mutual funds or ETFs,
commodity trading offers tremendous leverage. In trading
commodity futures, you typically only have to put up about 10% of
the total futures contract value. This enables you to make much
higher percentage gains with your trading capital. For example, you
could hold one S&P 500 Index futures contract with a margin
deposit of just over $20,000, while it would take several hundred
thousand dollars to buy each of the actual stocks contained in the
index. A 20% rise in the Index would return you a more than 100%
profit from buying a futures contract – you’d realize approximately
the same absolute dollar amount in profit as from buying the
stocks in the index, but you would have made that profit with a
much smaller investment.
Commodity futures trading may also offer lower commissions and
trading costs, although, with all the discount stock brokerages that
exist now, that’s not as much an issue as it was 20 years ago.
Commodity trading holds an advantage over illiquid investments
such as real estate since any money in your account that is not
being used to margin market positions that you’re holding is readily available to you at any time.
One really key advantage – a double advantage, actually – that
commodity trading offers is diversification within simplicity. There
are commodity futures available to trade that cover virtually every
sector of the economy – agriculture, energy, precious metals,
foreign exchange, and stock indexes. However, unlike the stock market where there are thousands of stocks to choose from – often
hundreds within any given industry – there are only a few dozen
commodity futures contracts to choose from. So, for example, if
cotton prices rise, then you can profit handsomely by being
invested in cotton futures contracts, whereas if you were trading
stocks, there are hundreds of companies to choose from whose
fortunes might be affected by the price of cotton but that would
also be affected by other market factors. You might end up buying
stock in a company whose share price falls due to other market
factors, despite a favorable change for the company in terms of cotton prices.
Finally, in commodity trading, it is just as easy to profit selling short
as buying long. There are no restrictions on short selling as there
are in the stock markets. Having the potential to profit just as easily from falling prices as from rising prices is a major advantage for
Commodity Trading Secrets – Find Your Market
Here is a little-known secret about consistently successful
commodity traders: They almost always specialise in trading either
a single market, such as cotton, or a small market segment, such as
precious metals or grain futures.
No one has yet offered a completely satisfactory reason for this
fact, but it remains a fact that very few traders seem capable of
trading all commodity markets equally well. There was a fairly wellknown trader back in the 1980s who had a nearly flawless trading
record in the cotton market. Copying his cotton trades back then
would have been about the closest thing to just printing piles of
money for yourself. Year in and year out, he called market highs
and lows and trend changes almost as if he’d traveled into the future and already seen them all unfold.
However, this uncannily brilliant cotton trader had one fatal flaw:
He also loved trading the silver market. Unfortunately for him, he
was just as outrageously bad at trading silver as he was
outrageously good at trading cotton. His weakness was
compounded by the fact that while he typically traded long-term
trends in the cotton market, he day traded the silver market, which
provided him with fresh opportunities to lose money every trading
day of the week.
How did this all play out for him? Well, in one year when he made over a million dollars trading cotton futures, he ended up filing a
net loss in trading for the year. That’s right – his horrifically bad silver trading had more than wiped out every bit of his huge profits
from trading cotton.
(Fortunately, this story does have a happy ending. After two or
three years of stubbornly losing money trading the silver market,
the gentleman did finally accept the fact that, “I just can’t trade
silver,” and very wisely stopped doing so. He continued piling up a
fortune trading cotton over the next several years, and finally
retired from trading with the very concise proclamation that, “I’ve made enough money and I’ve had enough fun.”)
And so we say: Find your market. It may take some time – and
some losing trades – to do this, but it isn’t really all that difficult to
determine, over a reasonable period of time, what you seem to
have a knack for trading – and what you don’t have a knack for
trading. A simple review of your trades over, say, a six-month
period should pretty clearly show you what markets you’re
frequently doing well in and what markets you aren’t having
success with. As you trade, you’ll probably also develop a feel for
which markets you feel most confident in trading. Trust your
instincts on that score. If profitably trading oil futures comes easily
to you, then just stick with that and don’t go trying to complicate
your life by trying to master trading some market that’s obviously
more difficult for you. Why make your trading life more difficult
than it need be? You’ll likely fare much better by gradually adding
trades in related markets such as natural gas or heating oil.
Large institutional traders such as banks have learned this basic
truth about trading well. At the trading desks in a bank, you’ll rarely,
if ever, find the same person assigned to trading both the gold
market and the soybean market. The common arrangement is to
have commodity trading very specialized, usually with one trader or
one team of traders and analysts assigned to trading just one
segment of the futures markets, such as energy futures or precious
Commodity Trading Secrets – Prices Tend to Trend
The supply and demand quotient for basic raw materials is usually
much less subject to ongoing volatility than is the case with stocks.
Certainly, there are some very volatile trading days, such as those
that occur at the end of major bull or bear trends when there are
long-term market reversals or following a crop report that comes
out unexpectedly good or bad. But generally speaking, there tend
to be sustained periods of time when high demand or short supply
controls a market, driving prices higher, or when oversupply or lack
of demand drives prices lower.
To confirm this, one need look no further than the past several
years in oil prices. After experiencing a multi-year bull market that
drove oil prices over $100 a barrel, from 2014 onward, oil prices
entered a sustained downtrend, eventually carrying the price back
below $40 a barrel.
Similar action occurred in a protracted bull market that drove grain
prices to record highs in the first decade of this century, followed
by a general decline in prices that has generally been sustained
since 2009. Again, while there are occasional sharp and volatile
movements in commodity prices, commodities typically experience
overall bull or bear trends that last several years.
Therefore, trend-following trading strategies – especially as applied
to long-term time frames such as daily, weekly, or monthly charts –
tend to work well in commodity trading. To demonstrate the
wisdom of trading with the trend, one noted technical analyst
devised a very simple trading strategy and then fine-tuned it by
matching it to the long-term trend according to the daily chart. His
basic trading strategy he devised was as follows: Buy a new 10-day high and sell short a new 10-day low. It doesn't get much simpler
That basic strategy worked well enough. It wasn’t a huge
moneymaker, but it was at least profitable overall. However, when
adjusted according to the overall trend as indicated by the daily
chart, the strategy performed markedly better. The adjustment he
made was to only take trading signals that were in the same
direction as the overall long-term trend. In other words, if the daily
chart showed an overall bullish trend, then he would only follow
the trading signals to “buy a new 10-day high,” while ignoring the
trading signals to “sell a new 10-day low”. Conversely, in an overall
bear market, he would only take the sell signals, while ignoring buy
He tested his strategy refinement by trading both strategies – the
basic strategy and the version adjusted to only take trades in the
same direction as the existing trend – using separate trading
accounts, over the same one-year period of time. The fine-tuning of
the trading strategy yielded an impressive improvement in
profitability. The fine-tuned version of the strategy, the one which
only traded with the existing trend, generated approximately 180%
more in profits than did the basic strategy that took both buy and
sell signals regardless of the existing long-term trend.
There’s another good reason to employ a solid, long-term, trend
trading strategy when investing in commodities. While commodities do tend to enjoy long-term trends, on a daily trading
basis they tend to be just the opposite – excessively volatile. Day
trading commodity futures – because of the leverage available
which makes even small price fluctuations significant as far as
potential profits or losses on any given day – does indeed offer
tremendous opportunities for profits. However, it’s extremely risky.
Any commodity trader who’s been at the game for a while can tell
you stories of days when the price of a given commodity has gone
from limit up (the maximum daily price advance allowed by the
exchange) to limit down (the maximum daily price decline allowed),
and then back to limit up again, sometimes within just a three or
four hour period. The odds of being able to successfully navigate
your way through price runs like that are slim and none.
Commodity Trading Secrets – Take Advantage of the Nature of the Market
Wise commodity traders know to pay attention to a factor that is almost unique to commodities as opposed to other investment vehicles and which tends to significantly drive prices – seasonality.
Nearly all major commodity markets usually tend to follow
established seasonal price patterns. A simple example is heating oil
and natural gas futures. Both of these commodities tend to, year in
and year out, rise into the winter months when demand is highest
and decline into summer as demand falls off.
Certainly, there may be specific economic conditions that disrupt
this general pattern from time to time, but over any 10-year period,
one can reasonably expect such general season price trends to run true at least seven or eight years out of 10.
There are specific seasonal patterns that traders can watch for, and
take advantage of, in commodity trading. Years ago, famed futures
trader, Jake Bernstein, put together a book on seasonal trends detailing dozens of seasonal patterns that occur throughout the
year in the various commodity markets, along with the historical record of what percentage of the time the markets stayed true to
each seasonal pattern. More recently, seasonal trading software
that basically incorporates such data has been created and is
available for traders to use.
Trading seasonal patterns is not a guaranteed win – nothing in
trading ever is – but it definitely offers traders an extra edge.
Seasonal patterns can be used as confirming indicators of an
existing trend, or as cautionary contrary indicators that may make a
trader wisely watchful for an upcoming trend change.
If nothing else, proper awareness of seasonal tendencies in various commodity markets can at least help you avoid suffering huge
losses. For example, only the bravest of traders ever holds a large
short sell position in orange juice futures heading into winter, when
just one overnight freeze can send the price of orange juice futures prices suddenly soaring.
Recent Developments in Commodity Futures Trading
The commodity futures markets have been hurt in recent years by both regulation and failures of regulation. Government attempts to regulate commodity trading have, unfortunately, resulted in
misguided legislation that has negatively impacted the markets
while failing to provide much in the way of real protection for
independent traders. For example, the infamous Dodd-Frank Act in
the U.S., enacted in 2014, effectively prohibited banks from
conducting short-term trading of their own accounts in the futures
markets, leading to a huge decline in liquidity in some markets as
many banks exited the commodity trading business.
Not only has legislation resulted in direct negative impacts on the
commodity trading markets, it has failed to effectively address real
issues such as price manipulation. There have been several cases in
recent years of large-scale traders manipulating commodity prices,
but government regulators have either failed to respond, or in
some cases even completely ignored this problem.
Commodity trading has also suffered from the loss of several major brokerage firms and commodity trading companies. Ironically,
many of these companies went out of business as a result of losing millions trading their own accounts. Accusations of accounting fraud have led to the demise of once well-known commodity brokerage firms such as Refco.
Learning about commodity trading offers traders significant
advantages, such as high amounts of leverage and the opportunity
to ride sustained bull or bear trends.However, commodity trading
is not a charitable organization that hands out suitcases full of
money to anyone who wants some. Just as is the case with any
other investing arena, it takes discipline and practice to become a
highly-skilled and successful commodity trader. One of the major
challenges is learning how to take advantage of the leverage
offered without exposing yourself to excessively high risks and
potentially disastrous losses.
If you enter the business of commodity trading with proper
caution – realising that you need to learn how to successfully
navigate a completely different trading arena than that of stocks,
forex, or other investments – then there’s no reason that you can’t
reap the rewards of highly profitable investments, all earned with
the use of a minimum amount of trading capital.