Saturday, July 12, 2008

Commodity Trading Basics: The Exchanges

In my previous post we covered some very general commodity trading basics primarily dealing with what types of commodities are available to be traded on the various commodity exchanges throughout the U.S. and some international markets. I had to laugh because I realized that I didn’t make any mention whatsoever of the actual exchanges themselves. For those who are just now warming up to the whole concept of futures trading and how it’s done (and where it’s done), the primary vehicle or entity that facilitates the buying and selling of futures contracts is the commodity exchange. In the U.S., there are several major commodity exchanges, and each one has its own set of commodities that are traded on a daily basis. The Chicago Board of Trade (CBOT) is where most of the major grains are traded such as corn, wheat, and soybeans. There is also an ancillary exchange in Chicago known as the Chicago Climate Exchange (CCE) where they trade—get this—greenhouse gas emission allowances, or carbon credits. Don’t ask me to explain that because I simply don’t know. Again, the more you read this blog and the more you become accustomed to my writing style, the more you’ll realize that I’m a very simple guy when it comes to trading futures, because after 7 years of being in the trading game and 7 years of observing, paper trading, and real-money trading the markets, I have learned that the simpler you keep this thing, the better. You don’t have to know every single detail as to how the commodity exchanges do what they do, you just have to know that when you buy, it’s bought, and when you sell, it’s sold. But, I digress…back to the exchanges. Another major commodity exchange is the New York Mercantile Exchange. This is where your metals (copper, silver, etc.) and energies (oil, natural gas, etc.) are sold. In my humble opinion, it’s also where the “scene of the crime” is right now, as far as why our gas prices are so high. Speculation has completely dominated the crude oil landscape, and the reason why oil prices are so high (and subsequently gas at the pump is so high) has nothing to do with supply and demand, but has everything to do with powerful inside interests that are basically pimping the markets (and the public) for their own benefit. This is another topic for another time but suffice it to say, there’s no such thing as “efficient markets” in the world of commodity trading; there are only those who are “in the know” and those who are not. There is only the weak money and the strong money. The weak money is basically the uninformed public, and the average speculator, who provide fantastic liquidity to the markets through their ignorance and willingness to jump into positions without any knowledge of what they are truly up against. If they were to simply study a price chart of the commodity that they want to trade, they would find out a little more about what type of move it’s making, and what type of trading action they need to take so that they won’t end up holding the “doo-doo” end of the stick, so to speak. But again, I will get to this a little later, as I have to finish my description of the commodity exchanges.

You also have the New York Board of Trade (NYBOT), which is where several of the foods/softs are traded, such as orange juice, coffee, sugar and cocoa, but in more recent years, they have added ethanol as a “trade-able” commodity as well. The NYBOT was featured in one of the most famous of 80’s movies, “Trading Places”, where a couple of the main characters were trying to single-handedly corner the orange juice market. Then there’s the International Monetary Market (IMM), where your currency futures (think U.S. Dollar, Japanese Yen, etc.) and interest rate futures (think Eurodollar and 1-Month Libor) are traded. The IMM is a subsidiary of the Chicago Mercantile Exchange (CME, also known as “The Merc”), where your meats (live cattle, pork bellies, etc.) are traded, as well as lumber, and your major equities as well (think S&P 500, NASDAQ 100, etc.). You also have the exchanges located in the Midwest, such as the Kansas City Board of Trade (KCBT) as well as the Minneapolis Grain Exchange (MGE), where the other types of wheat (hard red, spring, etc.) are traded. In summary, hopefully if I haven’t bored you to complete exhaustion by now, you will have gotten a better grasp on what types of commodity exchanges are out there. By no means have I listed every single one…I just don’t feel like doing that (LOL), but the ones I have mentioned are the most prominent ones, and the ones that I have personally traded through many times. These exchanges (most of them anyway) have very long histories, and many, many fortunes have been made and lost at these places. The markets are no place for the nervous trader, or the person who trades with what I call “scared money”, where you are obsessing over every tick and emotionally tied to every price movement. If this describes you, you are not ready for futures trading to any degree. The successful futures trader needs to have nerves of steel, and an emotional indifference to the market’s movements. I will cover this side of futures trading in more thorough detail in upcoming posts; it’s a huge subject, but in my mind the most important one to master for you to become a successful commodity trader, or stock trader, or any type of trader.

That’s gonna wrap it up for this installment of commodity trading basics. I encourage you to begin studying the price charts (especially historical price charts) of the different commodities to get a feel for their various price ranges and “personalities”, because each market does indeed have its own personality. We’ll tackle this later in a future episode of Commodity Trading Information—until then, keep on learning!


jorgon said...

I just wanted to add a comment to encourage you to continue with the series - it is looking very promising and interesting, although you do seem to be taking a while to build up to the point when you impart anything from your own personal knowledge and experience (and which is not available elsewhere). I have only been in futures trading for a short time, being a baby of the ETF funds which have opened up this area for amateurs. The ETF which I mostly use roughly follows the future price 3 months ahead. One thing I have already learned is that you cannot foretell how the 3 month future price will move by using the available futures price charts, showing for example prices 3 months, 4 months, 5 months ahead etc. You would expect that if there is a good upward trend for these months then the chances are that an ETF 3 month tracker would go up within a couple of months. But this does not happen within a couple of months. It does seem to happen eventually, but by that time the graph seems to change to show flat or downward trend - which I agree is extremely nerve wracking! I suspect there are many other factors at play and I would like to know what they are!

The Commodity Wizard said...

I appreciate the encouragement, thing I've learned is that for every chart you have with a different month, that actually represents an entirely different market. I'm not very familiar with ETF's, but in futures contracts there are people trading the July contract (whatever it may be) that aren't trading the August contract...they are truly different markets, being traded by different people, and must be seen as separate entities even though they will move in similar fashion. What I can tell you is that the main month to watch is the one that's closest to right now--this is known as the "front month". Bottom line, the price action on the front month chart really affects the other (later future) months more than anything else. Thanks for stopping by.