How to Make Money in Commodities
51
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Are these contracts candidates for method trading?
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Now look
at the charts for October Soybean Meal and July Platinum. Do
they qualify? Yes, they are strong potential candidates for
trading by our method. Soybean meal has been fluctuating in
a range of about $3 a ton for five months (or only about $300
per contract). Platinum hasn't moved much beyond a range of
$8 per ounce for 6 months (or only about $400 per contract).
No one would want to hold a position in these markets, as they
are not offering any substantial profits. But they do signal
the methodical trader to watch for the breakout. The longer
the time period in which prices trade within a narrow range,
the easier that market will generally be to trade for the commodity
futures speculator.
The moment
of truth comes when the trader tries to spot the actual breakout.
For the method to work,
price must eventually
move out of an established trading range by a meaningful
advance or decline:
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DECLINE OUT
OF TRADING RANGE
53
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ADVANCE OUT OF TRADING RANGE
The charts for December Cattle and December
Commercial Paper indicate price movements departing from
clearly defined channels. These contracts would become
serious contenders for trading, as they have demonstrated
both a long?standing sideways trend and a sharp move above
or below that trend. The trader in cattle will consider
buying futures contracts (going "long"). The
trader in commercial paper will consider selling futures
contracts (going "short").
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What causes formerly quiet commodities
to suddenly rise or fall in price? Most often, the weeks or
months (or even years) of sideways price patterns imply a balanced
and unchanging supply and demand situation. If something occurs
to radically upset that balance, altering the fundamentals
for the commodity, the breakout will probably follow. Thus
another indicator for the method trader will be a relatively
stable supply and demand relationship for the commodity over
a substantial period of time. Look back for a moment to the
silver chart and its price surge. Notice how once demand for
silver achieved dominance over available supply, this economic
situation was reflected in higher prices for many months. Although
the chart tells you the fact, whether price is really headed
up or down, fundamental information about the commodity will
help confirm or refute your analysis of the market.
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Place your order to buy above the old range.
55
Having once learned how to spot this type
of market, the speculator must then decide at what point or
price to buy or sell futures contracts. Many traders with a
keen eye for chart patterns and market opportunities nonetheless
suffer heavy losses from not knowing when and how to enter
or exit the market. A calm, logical look at the graph for the
commodity you wish to trade will usually give the answer. Don't
forget, you want to let the market decide your position, because
you can only profit by being with the market, not against it.
To buy futures contracts during periods of advancing prices,
place your orders above the previous trading range. To sell futures contracts during periods of declining prices, place
your orders below the previous trading range.
In the case of
January Soybean Oil, the trader expecting a rise in prices
would want to place a buy order around 7.8¢,
above the narrow trading range but not so far as to miss out
on the bulk of a price rise.
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Place your order to sell below the old range.
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In the
case of March Corn, the trader who anticipates a huge new crop
and a subsequent fall in prices
will want to place a sell order around $2.65. Some traders
would choose this point because its distance from the bottom
of the former narrow trading range is equal to one-half the
height (10¢) of the channel. Many other methods can be used
for determining the exact level, but the rule is always "Buy
above, sell below." If you had used this method to get
into the March Corn contract, the result would have been very
impressive indeed.
If you had sold at $2.65, and bought back
after the reversal reached $2.10, the 55¢ profit would mean
$2,750 per contract.
With initial margin at $600, profit would be 458% (minus commission).
"But," you
may well ask, "how do I know to get out
at $2.10?" Novice traders will be surprised to learn that
many speculators get wiped out because they don't know when
to take their profits. I wish I had a nickel for every time
a trader let substantial profits be erased by sitting through
a complete reversal of a once-favorable price move, vainly
hoping that yet another reversal will restore profits and add
to them. Learning how to let your profits run, and then how
to time your exit so as to take the bulk of those profits with
you constitutes one of futures trading's finest arts.
Let us
say that you have found the type of market you wish to trade.
Prices have been wandering sideways in a narrow range
and then moved out of that range, advancing or declining
decidedly. Acting according to plan, you have taken a position
in the
market, buying if prices are rising and selling if prices
are falling. You now hold real positions in the futures markets.
Be forewarned. This is not the time to relax! The battle
is
only half over at this point, and the most dangerous moments
in the life of the trade are still ahead. For you now have
actual money at risk in the market, and you want to
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58
eventually get out of that market with a profit,
or at least without having wrecked your commodity account.
The
other half of the battle centers on one key decision: At
what price do you wish to get out of the market? A method must
be employed for determining at what price to liquidate the
position, and an order formulated that will enable the pit
trader to get you out when you want to get out, and at the
price you want to get out at. At some time you will have
to
sell the contracts that you bought, or buy the contracts
that you sold. In either case, you want to buy low
and sell high.
It doesn't matter in which order you do this, as long as
you go with the market: you can buy low and sell high in a
rising
market or sell high and buy low in a declining market.
Whichever way it is done, the trader must decide the most
reasonable and opportune moment for exiting from the market.
Like the decision to enter the market in the first place, the
decision to exit from the market can be determined by the market's
actual price moves.
The first thing the speculator should do after establishing
a commodity futures position is to enter a "stop-loss
order." This
order is designed to protect the position from ruinous losses
by taking the trader out of the market when prices move adversely.
When taking the initial position, the speculator may have used
any number of orders to get into the market. One option would
be the "stop" order, which rests until the price
conditions match those of the order, at which time the "stop" is
tripped and the order executed at the market. A "stop-loss" order
is just like the normal "stop" order, except that
instead of putting you into the market, it will take you out
of the market. The stop-loss order instructs the broker to
offset (get out of) the original market position once a certain
price level has been reached. As the trader, you decide at
what level that should be, and instruct the broker
59
accordingly. The stop-loss order is planned and given
to the broker either together with or immediately after the
order that establishes the market position. A stop-loss will
be of little use if formulated
in haste when the market has already turned against the position.
Why is it called a "stop-loss"? The purpose
of the order is to stop your losses at a predetermined, acceptable
level,
before they do
irreparable harm to your commodity account. This puts into
action the universal law of commodity futures trading: Cut your
losses short and let your profits
run. The stop-loss aids the trader in sticking to a disciplined,
methodical plan for minimum losses and maximum profits. Before
the trade has even
been initiated, the computation of the stop-loss level lets
the speculator decide exactly (give or take a small margin
of error in actual execution)
how much could be lost in the worst circumstance. The amount
of money being risked is pin-pointed. The order tells the broker
that you do not wish
to lose more than $100 or $500 or whatever amount suits the
trading plan. When things go wrong and the stop is tripped,
the order will be executed
at the "best possible" price available. Caution: In
some cases, when prices are wildly fluctuating, it may not
be possible to offset your market position through the use of a stop-loss
order. Discuss this possibility
thoroughly with your broker before investing any money in the
market.
How would the "stop-loss" order be set by reference
to price history and the price chart? In the cases of September
Wheat and May Potatoes,
the following graphs clearly suggest what action to take. After
trading between $1.63 and $1.70 a bushel for nearly six months,
the price of wheat
rises to above $1.70 and heads for $1.75. The supply of wheat
that has equalled demand and kept prices in a narrow range
has evidently run out,
and the squeeze has sent prices higher. The
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