Technical Analysis is the Best Way to Trade Commodities
In the opinion of myself and many others, technical trading is the best way to trade commodities. I could care less about the news! That’s a bold statement, so let me explain why I say that. By the time you read or hear the news, it’s already happened. You see, you and I are on the bottom of the news chain. If you think otherwise, I’m sorry—you’re wrong!
But there are USDA Reports and Economic reports dates that have a huge swing that day in the markets. This is why I’ve made these calendars available for my students. You need to be aware of these reports dates. You need to know which reports are coming out and which reports can affect the markets. You do NOT want to get caught trading on the wrong side of a report date. We will talk in much more detail about this a little later.
To give you an example, as I was writing this, the price of gold was going up because the stock market was going down. Usually if the S&P or DOW Jones goes down then Gold will go up and vice versa. However, if you had been watching the charts, you would have seen the price start go up and could have made a trading decision, based on technical rather than just the fundamental information.
Also, fundamental traders have to be aware of the weather patterns around the world (for Grains and Meats and Cocoa & Sugar, etc. and how they might affect production. They also have to be aware of world “inventory,” and who’s dumping product on the market, etc. It would be a full-time job just to keep up with one commodity, much less with dozens that you might want to keep an eye on.
There are times, however, when certain fundamental information can be incorporated into your trading. The study of seasonal patterns is one thing that is not difficult to learn and can prove helpful at times. I've included a section on “Seasonals” that's available.
Now, on the other hand, we have technical analysis. I love the charts! I feel they tell you almost everything you need, once you understand how to read them.
You’re going to learn a lot about technical trading in this blog, and I hope you can master it. It’s not rocket science, it’s an art— but it’s not as complicated as you might think.
In any trades you make, you should always know your reward/risk ratio. How much are you willing to risk? What’s your upside (what you think you might make)? What’s your downside (the amount you might lose)? How much of your trading account should you risk on any one trade? It’s not as much as you might think!
Although no one can control which way the market is going, you can usually control your risk. If you don’t control your risk in trades, you won’t be around very long to have to worry about it. Would you risk $5,000 to make a possible $1,000? Those are horrible odds, yet I’ve seen people do this over and over until they are broke. However, would you risk $1,000 to make $5,000 if the odds were in your favor? Probably.
The key is to understand the reward/risk ratio on every trade you do and only trade the ones that have a lot more reward than risk. One way to look at reward/risk is by remembering the coin toss game we’ve all played as children. If you played with a nickel and your opponent played with a dime, and each time you won, he gave you a dime, and each time you lost, you gave him a nickel, who is going to win in the long run? Of course, you would. You might lose the first 5, or even 10 tosses in a row, but over time, you would win twice as much as your opponent, because your risk was 1/2 as much as his. Right? That’s exactly what we want to do when trading. We want the risk to be in our favor.
Just like in the coin toss example, we want the odds in our favor before we make a trade. Personally, I like my students to see a Reward/Risk ratio of 2:1 or better. In other words, if you have a chance of making at least $1,500 if your target is hit, then you don’t want to risk more than $750 on the trade. I’ve seen trades that have 3:1 or even a 4:1 ratio. I like to see these trades, and you will too. At times, you can put on a short term trade where you can have a little less than a 2:1 Reward/Risk ratio, but don’t do it all the time.
You are going to learn how to figure your profit targets and when to get into a trade a little later. You will also learn how to protect yourself, and how to control your risk. To do this, you need to know how to use stops.
The Stop Loss
“Stops” are simply orders to exit a trade at a predetermined price. Let’s say that you think the price of a certain commodity is going up, so you want to buy a contract (go long).
The stop loss is an order that is opposite of your entry order. In other words, if you go long on a contract, you would place a stop (an order to sell the contract and exit the trade) somewhere below your entry price. Let’s look at a generic example of going long on the following chart.
Since you expected the price to go up, you “bought” a contract to “go long.” You make money when the price goes up. But if the price goes down, you want to protect yourself. You want to limit your losses. In this example, you risked 108 points because you entered long from 56.41 and your stop loss (your sell order) was at 55.33. This means if the price went down to 55.33 or below, you would be “stopped out” with a loss of 108 points, because if the price dropped and “hit” your stop, your contract would be sold for a loss at that price. This loss would be paid from your margin “deposit.” Stops are just one way you can limit your losses when trading. We will cover other ways a little later.
THERE ARE CERTAIN TIMES THAT EVEN A STOP LOSS WILL NOT PROTECT YOU.
As an example, let’s say you were long the Silver market from $13.50 and you had a protective stop at $13.25. This means if the market drops down to $13.25, you would be stopped out with a loss of .25 cents, or $2,500.00. But what happens if you go to bed one night, wake up the next morning, and the price of Silver opened at $13.00? It never “hit” your stop in this case and you were stopped out at the opening price of $13.00, for a loss of $.50 cents, or $5,000! Don’t ask me how I know! It’s just one of the many risks in trading and something you need to be aware of. There’s not much you can do about it, either. It probably won’t happen to you at all, or not very often anyway, but you should be aware of it. (Remember my promise not to “sugarcoat” anything).
Every time you place an order, you should always place a stop at the same time. Never trade without a stop loss of some kind. Later in the series, you will learn to use options as a stop. You don’t want to put your stops too close to your entry price, because if you do, you will get “stopped out” during the normal day-to-day price fluctuations. I’ll cover the best place to put your stops later in the series. Right now, I just want you to be familiar with how they work.
Of course, the opposite would hold true if you were short, expecting the price to go down. If you place your “sell order” to go short Silver at $13.50, then you would want to place a buy stop at maybe $13.75, which means you will get stopped out for a loss if the price went up to or above $13.75. Again, this will be covered in more detail later.
Remember, I told you that sometimes the price may “open” the next day (trading session) at a much higher or lower price than high or the low of the day before? This is called a Gap and you will learn a lot about them later.
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* Testimonials are not a guarantee of future success. All information is for educational use only and is not investment advice. Trading financial instruments, including Stocks, Futures, Forex or Options on margin, carries a high level of risk and is not suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in any of these financial instruments you should carefully consider your investment objectives, level of experience, and risk appetite. Only risk capital should be used for trading and only those with sufficient risk capital should consider trading. The possibility exists that you could sustain losses exceeding your initial investment. You should be aware of all the risks associated with trading and seek advice from an independent financial adviser if you have any doubts. Past performance, whether actual or hypothetical, is not necessarily indicative of future results. All depictions of trades whether by video or image are for illustrative purposes only and not a recommendation to buy or sell any particular financial instrument and do not factor in trading costs in trading examples due to varying commission and fees among traders. The impact on market prices due to seasonal, market cycles or news events may already be reflected in the price. See full risk disclosure. See full risk disclosure.