Many people view the commodity markets simply as gambling. Obviously, this is a case of contempt prior to investigation. However, I’ll go with this analogy as we define a couple of crucial mistakes that I’ve seen over and over again in my 20+ years as a commodity broker and trader. First of all, let’s say you’ve been planning a trip to Vegas and you’ve been reading up on counting cards at blackjack or hedging strategies designed for the craps table.
Upon your arrival in Las Vegas, it’s safe to assume that you wouldn’t attempt to implement your newfound knowledge at the high roller tables. Similarly, you wouldn’t put your newfound trading knowledge to work in a highly volatile commodity market like the full size crude oil or 30-year Treasury bond markets.
Here are a few tips that will help you wade into the waters of commodity trading without risking all of your capital.
The first step towards successful trading involves a bit of self-analysis. How patient are you? Are you expecting to trade months long trends or, are you going to day-trade? Are you a technical trader or a fundamental trader?
Once you’ve been able to align your personal timeframe with a corresponding strategy, you can begin looking at markets that fit this description. Please, don’t take the self-analysis portion lightly. Fighting the markets is hard enough without having to fight your inherent human nature as well. Therefore, let’s look at some markets and trading strategies that may allow you to test your strategy appropriately.
Trend trading is typically defined by these characteristics – low winning percentage, long holding time, wide protective stops and giving back a large portion of open position profits upon exiting the market. Trend trading attempts to latch onto macroeconomic themes that develop over time. The seismic shift from Quantitative Easing and generationally low interest rates to a hawkish Federal Reserve Board beginning to raise rates is a macroeconomic theme that many will be attempting to catch in the coming years.
Let’s examine the difference between the 2-year Treasury Notes and the 30-year Treasury bond market. Both of these markets maintain a high degree of correlation and will be impacted by rising rates proportionately. The major difference lies in the average day’s Dollar movement. Recently, the average range in the 30-year T-Bonds has been around two full points, which is equal to $2,000 per contract. Compare this with the 2-year T-Note, which has an average range of approximately 10 ticks or, $325. Furthermore, the margin requirements for these two products are $3,740 and $715, respectively. Finally, if you feel we’ve reached the top in the interest rate markets and would like to bet on rates rising beginning with the September 2015 Fed meeting, the risk from our current levels to the all-time high in the 30-year T-Bonds is nearly $10,000 per contract while the same trade in the 2-year T-Note is less than $500.
Perhaps, trend trading is not your thing and you see yourself as more of a swing trader – buying below value and selling above value while taking profits from either side as the market returns to your pre-determined value area. Oscillations like this lend themselves well to technical momentum indicators. This type of trading is very typical in the agricultural markets where supply and demand is driven by relatively known values like acreage, yield, cattle weight, hog production, etc. Even crude oil falls into this category. But again, you don’t want to test your newfound knowledge at the biggest game on the floor. Therefore, your strategy is better tested on the corn market, which is bound by similar variables as the soybean market with a fraction of the bean market’s volatility. Moving to our average range and dollar value calculation shows that beans have an average range around $.18 or, $900 per contract. Meanwhile, the corn market has experienced volatility around $.075 per bushel or, $375 per day. Furthermore, the margin requirements are $2,860 for beans versus $1,375 for corn.
Finally, we’ll move to the day traders. Many people are drawn to day trading the stock indices based on their lifetime’s exposure to the stock market. The idea of lower day trade margins, typically half of the full contract margin, is more often a trap to get amateurs to overtrade similar to the free drinks being served in the casinos. While trend trading can take months to determine the efficacy of your strategy, day traders, especially amateurs, can find themselves broke before they even know if their methodology suggests a positive expectancy.
The two biggest points to make about beginning to day trade are sticking to your strategy and not over trading due to proximity. If you feel confident in your mental disposition and your strategy, you need two things for successful day trading. First you need a deep market that will minimize slippage. Secondly, the market has to have enough movement to generate profits beyond what slippage and commissions will eat up. Therefore, I suggest the e-mini S&P 500 futures contract for beginning day traders. There are several hundred contracts available at every tick and typical volatility still provides nearly $2,000 in average Dollar based movement. Meanwhile, more seasoned day traders may prefer the Russell 2000 futures, which typically have a range in excess of $2,500 per day.
Trading futures intelligently requires wading into the pool, not a cannonball. Begin by analyzing yourself and what you expect out of your strategy. Secondly, find low volatility markets to test your method. Finally, plan your trades and trade your plan. This is much easier when the market you’re in is financially palatable rather than agonizing over every tick because the size of the contract is too big relative to the account it is being traded in. Remember, the markets are ruthless and losing your shirt won’t net you a comped dinner and a show.
