One of the draws for people looking to learn how to trade commodity Futures is the outstanding profit potential for the astute trader. This can lead some people into buying into the “secrets” offered by “market gurus” only to realize, after great expense, that there are no secrets to trading success.
The biggest barrier to trading is not capital but is a lack of knowledge of risk, leverage, trader psychology and the trading plan to be used. There is a lot to understand but most people can understand the components of trading but finding consistent success is another story.
If you are zeroing in on commodity trading, it is probable that you are entering as a speculator and not a hedger. Your aim will be to make quick transactions lasting minutes to hours and build a steady income to either replace or add to your current income.
There are many commodities you can choose to trade and many traders pick a handful to trade on a consistent basis. You have four major categories to choose from:
- Agriculture – Wheat, Coffee, Sugar
- Energy – Crude Oil, Natural Gas, Heating Oil
- Metals – Gold, Silver, Copper
- Meat/Livestock – Hogs. Cattle, Pork Bellies
When you buy a Futures contract on oil for example, you actually agree to purchase the barrels of oil when the Futures contract expires in March, June, September or December. You never actually take possession of the commodity because you generally will liquidate your position at X price. The difference between your purchase price and liquidation price will be your profit or loss.
There are several methods to approach trading and when you learn to trade commodity Futures, you will either trade fundamentally or use technical analysis of the markets.
Fundamentals: With commodities, you are looking at pricing based on supply and demand. As a trader, you will be looking to find out if the supply/demand balance will change. This can be through political intervention, war, weather and other variables.
Using crude oil as an example, when there is a flare up in the Middle East, you will notice an increase in the price of crude as there is an expected impact in the supply of the commodity. A trader using pure fundamental analysis will keep their finger on the pulse of any activity that can influence the supply/demand balance.
Market demand can also have a direct impact on the price of the commodity and determine whether you want to buy or sell a particular commodity. It also goes hand in hand with supply.
What would happen if North America decided on the “Paleo” way of life and gave up wheat? The demand would fall and so to would the prices. You would not want to be long wheat if this occurred.
Technical Analysis: This is where the past market behavior is studied and a decision is made whether to take or liquidate a position. There are three main attitudes that the technical analysis must take when approaching their price charts
- Everything that can affect the price has been factored into the current price. This means that any supply/demand imbalance has already been priced in and that the current price is accurate as to the value of the commodity.
- Price trends up, trends down or travels in a range with a defined support and resistance level.
- What happened in the past will repeat itself in the future.
Take a look at this weekly Natural Gas chart.
These are simply trend lines and support lines and the circles are areas that potential trades were in play. You will find out all about trading these lines when you learn to trade commodity Futures and keep in mind this is the most basic method of trading. All these areas would have been identified in advance and you would have simply waited for price to meet these areas. Your trading plan would indicate when it would be time to enter the trade.
Margin Makes Your Decision
While it may be a neat thing to tell people you trade “Soybeans”, your capital and the margin required is what determines the choices available to you.
Margin: Money loaned to you through a broker to enable you to purchase a Futures contract. You give your broker a deposit equal to a percentage of the security price you hold
These are some sample margins from a popular Futures broker:
Soybeans – $4050 Brent crude – $5750 Propane – $3800 Silver – $14218 Frozen OJ – $1925
Once you open your account at a broker, you make an initial deposit. Once you open a trade, the required margin is held from your account until you close your position. Margin amounts vary from broker to broker and due diligence is required when investigating which broker you want to work with.
When you learn to trade commodity Futures, one thing you should pay close attention to is the volatility of the market. Is it a liquid enough market where you can exit a position with the least amount of slippage at a time you deem appropriate? You will learn the importance of a protective stop loss and if hit, will there be a counter party to your trade? If not, your stop will not get filled and your capital exposure will exceed the amount you originally planned for.
While there are many markets you can trade, not all markets are the best for your attention. You can find some of the most popular markets that are traded by the Netpicks team by reading the posts that are on this blog.
What Type of Commodity Trader Are You
Often overlooked is understanding the type of trader you are and many times that is determined by your psychological build. Some people can handle the pressure of scalping or day trading where they sit and watch the charts during the day. It is a quick way to make profits and can be a fast way to drain your trading account.
Taking multiple positions throughout the day will also cost you in commissions and while those can be small, they do add up especially is you are not offsetting the cost with winning trades.
Are you able to hold positions overnight, accept the risk, watch your profit/loss fluctuate and still hold true to your trading plan? If so, swing trading or position trading may suit you instead of scalping.
Regardless of the type of trader you are, they all share a common trait and this is capital exposure and managing your risk is paramount to your success.
You may hear that you should never risk more than 2% of your overall trading account in a trade. That number may vary but what is simply means is never bet the farm on one trade.
Whether you are a fundamental trader or technical trader, you will suffer losses. While you think you may be ready to lose, many people are not as prepared as they think they are. Understand that losses are all part of the business and the only thing you can do is manage your exposure and limit your losses when they come.
If you are trading a $10000 account and risk 2% on a trade, you will only be able to buy/sell the number of contracts that would not exceed your available exposure amount of $200.00. This will also depend on the size stop which is the difference between your entry price and the price you will exit a losing trade at.
There are many aspects to trading that cannot be covered in one post. Premier Trader University is a great place for those who want to learn to trade commodity Futures. You can also view this video on how to create an income trading futures to get a better idea if commodity trading is for you.