Any time you want to discuss commodity trading basics you’re going to have to mention the importance of developing a disciplined trading methodology, and applying sound risk and capital management to your trading habits. There’s no way on God’s green earth that you can expect to have any longevity trading in the futures markets if you neglect to discipline yourself to stick to a well-thought-out trading plan. And this applies to any market; I could be talking about oil trading basics, or corn trading basics, or any of the other derivatives; it really doesn’t matter which particular market you choose, the importance of developing a sound, reasonable trading plan. This, surprisingly, will be the most difficult part of your trading career. Truth be told, if you never settle this part of your trading career, you won’t have a trading career after long. A fool and his money are soon parted—so are a trader and his money if he doesn’t have a well-thought-out trading plan. So you may be thinking “What should I include in my trading plan?” Well, for starters, you need to know how much total capital you want to start with. Most commodity trading advisors recommend starting with no less than $50,000, but this number greatly varies. I didn’t start with anywhere near $50,000. I started with $1,000, and quickly blew that account completely out. When I started again, I started with $4,000 and did much better. Looking back on it, I would never have started with less than $10,000, knowing my own personal risk tolerance and personality. That’s the part that really no one can teach you, is how much money you can handle putting at risk. Many people trade way beyond their emotional tolerance level—in other words, they’re overloading their emotional capacity by risking WAY more trading capital than they’re comfortable with losing…and the one thing I’ve learned over the years is that you NEVER risk more money than you’re willing to outright lose. If you can’t kiss it goodbye without missing it, you will never trade successfully. The chance of that happening is always there, and anyone who’s ever been caught on the wrong side of a limit move can tell you that it’s there.
Commodity Trading Basics: Limit Moves
As an aside, for those who may not know, a “limit move” is when a market moves its absolute maximum in one trading session, up or down. The commodity exchanges have set limits on price moves so that there will be no extreme “runaway” markets in one day. Can you imagine if speculation went completely wild in a trading session, and Wheat moved up 200 cents in a trading day? That would be a $10,000 loss (per contract) in ONE DAY for the guy who’s on the short side of Wheat—talk about no fun!!! So, the exchanges implemented a “limit move” restriction on prices for extreme trading conditions—when a limit move occurs, you’ll see a little horizontal “tick” on the price chart—it looks like a little hyphen—with nothing else around it. If prices move up to the daily trading limit, it’s known as going “limit up”. If prices move down to the daily trading limit, it’s known as going “limit down”. For instance, (if memory serves me correctly) there was a time back in the 1970’s where soybeans skyrocketed, and went limit up for consecutive days. It would suck horribly to be on the short side when a commodity is going limit up, and it would suck horribly to be long when a commodity is going limit down. Many a trader has been wiped out by limit moves; that’s why it’s always good to protect your positions by buying options that are opposite of your position. For instance, if you’re long Coffee, you could buy a put option at or near your entry price to partially shield you from downside risk, or if you’re short Oats, you could purchase a call option to partially protect you from getting caught in a violent upswing in price. As far as the details of these types of trades, we’ll have to cover them in future posts…this one is long enough already (ha ha).
Well, I wasn’t expecting to go off on the “rabbit trail” regarding limit moves, but since this blog is about commodity trading basics, it didn’t hurt at all to cover them the way we did. Hope you got something out of it!
Wednesday, July 22, 2009
Sunday, April 19, 2009
Commodity Trading Basics (Part 2)
Commodity Trading Basics - Developing a Trader's Mentality
If I could put this post about commodity trading basics in some type of chronological order, it would actually follow an earlier post I made entitled “Futures Trading: Some Things You Should Know”. As I have stated before many times, and will continue to consider it one of my “trading mantras”, if you will, the simple fact of the matter is that to become a truly solid futures trader, you’re going to have to recognize what’s in your control and what’s out of your control. The markets, for the most part, unless you’re able to put on positions that hold dollar values in the trillions, are OUT of your control. You can’t do squat about what Lean Hogs does, what Coffee does, or what the S & P E-mini does today, next week, or any other time for that matter. The markets are so vast and so varied that sooner or later you finally realize that any position you put on, whether long or short, you’re at the markets’ mercy every second, and it’s a doggone miracle sometimes that you don’t just get blown out of the markets entirely by some cataclysmic move in prices. We have our stop-losses (and you should), and we have our fancy indicators, and we have the comforts of all of our technical analysis tools and software, and we have enough fundamental market data to circle the globe 10 times, but again I say, at the end of the day, the markets will have the final say-so. All of our research may have put us in a decent position to make an informed decision about whether or not to open a long or short position, or how many futures contracts we should trade, and a host of other things that go into planning a trade (by the way, you should ALWAYS have a trading plan), but once you place that order and enter the arena, be prepared for whatever it may throw your way.
Consider this true story: I was trading a silver option one time, and I was basing my decision to buy a put option (a topic we’ll have to get into in another post—please forgive me for “skipping ahead”, so to speak) on a particular chart pattern that I have personally seen work over and over again…it’s known as a flat-bottom triangle. Again, this is something that we’ll have to delve into over time, but basically, the way I trade is through examining commodity charts and then making my trading decisions based on commonly recurring chart patterns that are present in almost every market. At any rate, this particular chart pattern, known as the flat-bottom triangle, was a really good candidate for a trade, primarily because it presented itself in a downtrend. Nine times out of ten, once the prices break below the “base” of the triangle (the flat bottom), they will continue in that direction. So, being used to seeing these types of chart formations (and profiting from them), I placed a fatter-than-usual order for a Silver put option—I paid more for it than I would normally pay for an option, because I bought it closer to the money (another term we’ll have to get to at another time). Long story short, I was SO convinced that the chart pattern was going to work out, and that prices were going to go exactly where I envisioned they were going to go, that even when the external evidence presented something entirely to the contrary, I was so wrapped up in my own expectations of what I thought the market was GOING to do, that I completely missed what it was actually DOING. Consequently, I stayed in the trade way too long, mainly on the premise that it “just HAS to do” what I believed it was going to do. Well, the formation fell apart; it never broke below the support level like I thought it would (yet another topic for another time), and I ended up just watching the passage of time completely eat away at the value of that option, until I ended up closing the position with only about $100.00 left on an option that cost WAAAY more than that. Lesson learned: You can’t do that too many times and still survive in the markets. When you start realizing that the trade is simply NOT going your way—and the simple test is, “Are you losing money?”—you start realizing that all of your wishful thinking and grandiose predictions of what the market “HAS to do” simply aren’t going to stop the market from doing what IT wants to do. So again, if you want to get serious about becoming a proficient futures trader, and you want to master some true commodity trading basics, get a handle on this one fact: The markets are going to do what they’re going to do, and you’re going to have to learn how to be “fluid” enough in your trading style to cut your losses and let your winners run.
If I could put this post about commodity trading basics in some type of chronological order, it would actually follow an earlier post I made entitled “Futures Trading: Some Things You Should Know”. As I have stated before many times, and will continue to consider it one of my “trading mantras”, if you will, the simple fact of the matter is that to become a truly solid futures trader, you’re going to have to recognize what’s in your control and what’s out of your control. The markets, for the most part, unless you’re able to put on positions that hold dollar values in the trillions, are OUT of your control. You can’t do squat about what Lean Hogs does, what Coffee does, or what the S & P E-mini does today, next week, or any other time for that matter. The markets are so vast and so varied that sooner or later you finally realize that any position you put on, whether long or short, you’re at the markets’ mercy every second, and it’s a doggone miracle sometimes that you don’t just get blown out of the markets entirely by some cataclysmic move in prices. We have our stop-losses (and you should), and we have our fancy indicators, and we have the comforts of all of our technical analysis tools and software, and we have enough fundamental market data to circle the globe 10 times, but again I say, at the end of the day, the markets will have the final say-so. All of our research may have put us in a decent position to make an informed decision about whether or not to open a long or short position, or how many futures contracts we should trade, and a host of other things that go into planning a trade (by the way, you should ALWAYS have a trading plan), but once you place that order and enter the arena, be prepared for whatever it may throw your way.
Consider this true story: I was trading a silver option one time, and I was basing my decision to buy a put option (a topic we’ll have to get into in another post—please forgive me for “skipping ahead”, so to speak) on a particular chart pattern that I have personally seen work over and over again…it’s known as a flat-bottom triangle. Again, this is something that we’ll have to delve into over time, but basically, the way I trade is through examining commodity charts and then making my trading decisions based on commonly recurring chart patterns that are present in almost every market. At any rate, this particular chart pattern, known as the flat-bottom triangle, was a really good candidate for a trade, primarily because it presented itself in a downtrend. Nine times out of ten, once the prices break below the “base” of the triangle (the flat bottom), they will continue in that direction. So, being used to seeing these types of chart formations (and profiting from them), I placed a fatter-than-usual order for a Silver put option—I paid more for it than I would normally pay for an option, because I bought it closer to the money (another term we’ll have to get to at another time). Long story short, I was SO convinced that the chart pattern was going to work out, and that prices were going to go exactly where I envisioned they were going to go, that even when the external evidence presented something entirely to the contrary, I was so wrapped up in my own expectations of what I thought the market was GOING to do, that I completely missed what it was actually DOING. Consequently, I stayed in the trade way too long, mainly on the premise that it “just HAS to do” what I believed it was going to do. Well, the formation fell apart; it never broke below the support level like I thought it would (yet another topic for another time), and I ended up just watching the passage of time completely eat away at the value of that option, until I ended up closing the position with only about $100.00 left on an option that cost WAAAY more than that. Lesson learned: You can’t do that too many times and still survive in the markets. When you start realizing that the trade is simply NOT going your way—and the simple test is, “Are you losing money?”—you start realizing that all of your wishful thinking and grandiose predictions of what the market “HAS to do” simply aren’t going to stop the market from doing what IT wants to do. So again, if you want to get serious about becoming a proficient futures trader, and you want to master some true commodity trading basics, get a handle on this one fact: The markets are going to do what they’re going to do, and you’re going to have to learn how to be “fluid” enough in your trading style to cut your losses and let your winners run.
Friday, January 16, 2009
Commodity Trading for Beginners
One of the things I had planned to do when starting this blog was to teach commodity trading for beginners. I started realizing that there are so many people out there who are just like I was when I started trading—absolutely clueless (LOL). The type of knowledge required to trade commodities or futures is what (I guess) can be called “specialized knowledge”; in other words, it’s not knowledge that’s picked up just by living your life; you have to actively pursue the knowledge to even gain a basic understanding of the futures markets. Since most people haven’t studied for a Series 7 license or whatever, I thought it would be good to explain some of the basics of futures trading so that it can be easily understood to the novice. One of the things that I hope to achieve with this blog is to have something that I didn’t have when I started trading—a place to get knowledge about the futures markets fairly easy, instead of doing hours and hours of research on the Web to find out different nuances of the futures markets—it was much like looking for a needle in a haystack many times. Talk about frustrating…but really, through nothing more than trial and error (and a WHOLE LOT of reading on the Web) I gained a basic knowledge of the futures markets, opened my account with just $1,000, and haven’t looked back since.
One of the things I have learned through my experience in the markets is that many people have failed to grasp even the very basic parts of commodity trading, including the trading symbols. See, the futures market is much like the stock market, in that the instruments that are traded on the markets have symbols that represent what each particular futures contract is. The ticker symbols of the stock market are for the most part longer than the symbols for the futures markets, since there are far less instruments being traded on the futures markets than in the securities market, but the volume is MUCH larger in the commodities market than in the stock market, meaning, a whole lot more money changing hands. At any rate, as an example, the symbol for Corn is “C”, the symbol for Wheat is “W”, the symbol for Rice is “RR”, the symbol for Lean Hogs is “LH”, etc., etc…it’s actually too numerous to list here. Since I’m definitely not one to re-invent the wheel, I’m just going to refer you to Barchart’s list of commodity symbols at this link: http://www2.barchart.com/futures.asp. Basically, the symbols are what you’ll see when looking at commodity price quotes, and the usual format they follow is the futures symbol, then the contract month (explained below), then the contract year. For instance, if I was trading a December 2008 Corn contract, I would see this symbol on the futures quote list: CZ08. The “C” is the symbol for Corn, then the “Z” is the symbol for December (each month has its own letter symbol as well), then “08” is, of course, the contract year. Meaning, that contract is valid up until what they call the Last Trading Day (LTD) in December of 2008. At the point that the contract expires, if you haven’t yet offset (or exited) your position, you will be obligated to take delivery of 5,000 bushels of Corn (if you were long), or to sell 5,000 bushels of Corn to someone else (if you were short). Remember that a long futures contract is simply a contractual obligation to buy a set amount of a certain commodity at a fixed date in the future (hence the name), and a short futures contract is a contractual obligation to sell a set amount of a certain commodity at a fixed date in the future. The markets were actually created to help large commercial users of commodities (think General Mills for Corn & Wheat, think major electrical wiring companies for Copper, etc.) as well as farmers and other commodity users have an orderly place to do business and exchange goods. Think about it: If you were making some bread and you realized that you had run out of flour, you would simply go to the nearest grocery store and buy a bag of flour. But huge commercial producers such as Gold Medal Flour can’t operate with that same lack of planning, or they would soon be out of business. So they basically place an order for X number of bushels of wheat (to make the flour) through a commodity exchange by way of a futures contract. They may not want or need the wheat right now, but they will anticipate how much they need a few months down the line and place an order for FUTURE delivery of the wheat, by way of a futures contract. They will purchase the contract through a futures broker at the prevailing market price for wheat—let’s say that wheat is currently trading at $4.50 a bushel (the standard contract size for wheat is 5,000 bushels). Once they purchase the futures contract, they have done what’s known as “opened a position” in the Wheat market, which basically enables them to "lock in on" the current price of wheat, even though it can change for the better or for worse. The price of wheat futures will fluctuate on a daily basis, due to the fact that it is indeed based on FUTURE delivery, not wheat that you are carrying home the same day you purchased it. Since nobody knows the future, and several factors that affect wheat prices can come into play between the time the futures contract is purchased and the time that the contract is up for expiration (and delivery), the price of wheat futures will continue to be volatile. This is what creates opportunities in not only the Wheat market, but every other market as well. These price fluctuations that happen throughout the life of a futures contract can either put tons of money in your pocket or extract tons of money out of it.
I’m extremely sleepy right now (it’s really late here), so although I feel like I gave a somewhat half-baked explanation of the basics of futures trading, I will continue along these lines of explaining commodity trading for beginners…hopefully someone will learn something along the way.
One of the things I have learned through my experience in the markets is that many people have failed to grasp even the very basic parts of commodity trading, including the trading symbols. See, the futures market is much like the stock market, in that the instruments that are traded on the markets have symbols that represent what each particular futures contract is. The ticker symbols of the stock market are for the most part longer than the symbols for the futures markets, since there are far less instruments being traded on the futures markets than in the securities market, but the volume is MUCH larger in the commodities market than in the stock market, meaning, a whole lot more money changing hands. At any rate, as an example, the symbol for Corn is “C”, the symbol for Wheat is “W”, the symbol for Rice is “RR”, the symbol for Lean Hogs is “LH”, etc., etc…it’s actually too numerous to list here. Since I’m definitely not one to re-invent the wheel, I’m just going to refer you to Barchart’s list of commodity symbols at this link: http://www2.barchart.com/futures.asp. Basically, the symbols are what you’ll see when looking at commodity price quotes, and the usual format they follow is the futures symbol, then the contract month (explained below), then the contract year. For instance, if I was trading a December 2008 Corn contract, I would see this symbol on the futures quote list: CZ08. The “C” is the symbol for Corn, then the “Z” is the symbol for December (each month has its own letter symbol as well), then “08” is, of course, the contract year. Meaning, that contract is valid up until what they call the Last Trading Day (LTD) in December of 2008. At the point that the contract expires, if you haven’t yet offset (or exited) your position, you will be obligated to take delivery of 5,000 bushels of Corn (if you were long), or to sell 5,000 bushels of Corn to someone else (if you were short). Remember that a long futures contract is simply a contractual obligation to buy a set amount of a certain commodity at a fixed date in the future (hence the name), and a short futures contract is a contractual obligation to sell a set amount of a certain commodity at a fixed date in the future. The markets were actually created to help large commercial users of commodities (think General Mills for Corn & Wheat, think major electrical wiring companies for Copper, etc.) as well as farmers and other commodity users have an orderly place to do business and exchange goods. Think about it: If you were making some bread and you realized that you had run out of flour, you would simply go to the nearest grocery store and buy a bag of flour. But huge commercial producers such as Gold Medal Flour can’t operate with that same lack of planning, or they would soon be out of business. So they basically place an order for X number of bushels of wheat (to make the flour) through a commodity exchange by way of a futures contract. They may not want or need the wheat right now, but they will anticipate how much they need a few months down the line and place an order for FUTURE delivery of the wheat, by way of a futures contract. They will purchase the contract through a futures broker at the prevailing market price for wheat—let’s say that wheat is currently trading at $4.50 a bushel (the standard contract size for wheat is 5,000 bushels). Once they purchase the futures contract, they have done what’s known as “opened a position” in the Wheat market, which basically enables them to "lock in on" the current price of wheat, even though it can change for the better or for worse. The price of wheat futures will fluctuate on a daily basis, due to the fact that it is indeed based on FUTURE delivery, not wheat that you are carrying home the same day you purchased it. Since nobody knows the future, and several factors that affect wheat prices can come into play between the time the futures contract is purchased and the time that the contract is up for expiration (and delivery), the price of wheat futures will continue to be volatile. This is what creates opportunities in not only the Wheat market, but every other market as well. These price fluctuations that happen throughout the life of a futures contract can either put tons of money in your pocket or extract tons of money out of it.
I’m extremely sleepy right now (it’s really late here), so although I feel like I gave a somewhat half-baked explanation of the basics of futures trading, I will continue along these lines of explaining commodity trading for beginners…hopefully someone will learn something along the way.
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