Commodity Market Trading Strategies


Time plays a big role in investments of all kinds. Some investments play over the long term, while some require a short period of time to mature.

Commodity futures fall in the latter category—they are short-term investment instruments that mature within a year, unlike stocks, bonds, and real estate.

So how can you make money on commodity futures within this short time frame? Be informed about market developments and react quickly to price movements.

While your reactions should be informed and spontaneous, they must never be random. Put in place a good trading plan beforehand and make your moves in line with your plan.

In this chapter, we will discuss the various sources of market information and the components of a good trading plan.

Information

As a commodity market participant, you will need two kinds of information. One is about the current market prices. The other is about the factors that can affect market prices in future.

Information on the prevailing prices and market developments is available in financial dailies, specialised commodity magazines, business channels, and the internet.

For market analysis and future predictions, look at the editorials or the ‘experts’ sections in financial dailies and websites. Research reports released by brokerage houses are another important source for analyses and predictions. You may also subscribe to e-newsletters prepared by market think tanks and research houses.

Trading plan

You can only use information to your advantage if you have a good trading plan. Otherwise, you may use information to buy and sell futures contracts at random. But this could lead to losses and investment mistakes.

A good trading plan is always trade-specific. It includes the following features:

  • Objective : Start by identifying whether you are in the market to hedge your risks or to make a profit. If you are a hedger, you might only trade in the commodities to which you have an exposure. You would be happy to square off your positions having made neither a profit nor a loss. As a speculator, you might not have any exposure. You could trade in any commodity and focus only on making a profit.
  • Risk appetite : If you are a hedger, your risk tolerance will be lower than that of a speculator. Your only concern is not to make a loss. You would not take extra risks to make a profit. As a speculator, you are in the market only to make money. You would take extra risks if you see the opportunity to earn higher returns.
    Based on your risk appetite, you can define the maximum percentage of your portfolio that you are willing to risk on each trade. For a hedger, the extent of his exposure would mostly determine this. For a speculator, this may depend on his confidence in the trade and the amount he can bear to lose.
  • Targets : Before entering a trade, decide on your target return and the maximum loss limit. The price that gives you your target return is your ‘take profit’ level. The price at which you suffer your maximum bearable loss is your 'stop loss' level. Be disciplined and exit the trade as soon as the price reaches one of these levels.
  • Review mechanism : You may have to adjust your trading plan in the light of new market developments or personal circumstances. This may even involve changing your ‘take profit’ and ‘stop loss’ levels. To ensure that your plan is consistent with market developments, decide on a frequency for its review. Conduct the review together with your broker or financial adviser.

What next?

Now that you are armed with the right information and a plan, let’s go through the process flow in commodity futures trading in the upcoming chapter.

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