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.