How to Make Money in Commodities

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EXAMPLE:
Buy IBM stock at $50 per share	Buy May Pork Bellies at 40¢/Ib
Sell IBM stock at $75 per share	Sell May Pork Bellies at 47¢/Ib
Profit per share: $25	Profit per pound: 7¢
Number of shares: 100	Pounds per contract: 38,000
Total Stock Trade Profit: $2,500       Investment: $3,750       Return: 67%	Total Futures Trade Profit: $2,660       Investment: $1,200       Return: 222%

click to enlarge

What advantages have we gained by trading futures instead of stocks? The profits are almost equal. The differences in timing, risk, and return on invested capital, however, are dramatic. A 50 percent price move in stocks can take a very long time, possibly years. The average commodity position is held for a few days, rarely for more than a few weeks. A 7¢ move in pork bellies, with trading limits set at 4¢ per day, could take only two trading sessions. The amount of margin money required to buy the stock would be from 60-90 percent

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of its value. At, say, 75 percent, the stock trader would have to put up $3,750, and let it sit there for months or years waiting for a significant move in price. The margin on the pork belly contract would be about $1,200, making for a profit of over 200 percent in two days' time. Of course an adverse price move in bellies could wipe you out just as quickly, unless your trading method protected you against this possibility.

      Who are these people trading commodities, and realizing such unheard of profits? Private and government studies profiling the "average" commodity trader reveal that he or she is much like you or me, someone with a moderate amount of capital to use as risk money and no special knowledge of the commodities traded. The boom in futures trading has brought every conceivable type of player into the futures markets. I have corresponded with traders who are bankers, farmers, ranchers, penitentiary prisoners, retired persons, secretaries, postal workers, corporation executives, doctors, blue-collar laborers and white-collar professionals. These people see futures trading as an exciting field of investment, a hedge against the increasing instability in modern economies, and as a game that challenges one's personal skills and talents.

      The people who have discovered the advantages of commodity futures trading have done so despite a cloud of misconceptions that has hidden the trade and obscured its workings for many years. It's time to clear away a few of them.

      The first great misconception is that it takes a great deal of money to trade commodities. The truth is exactly the opposite. Futures trading is one of the few, and one of the most practical, ways of turning a small amount of money into a fortune. Many, many traders have less than $10,000 or $15,000 invested in commodity futures. Compare this to the average stock market account of from $50,000 to $100,000. In fact, too much money invested in futures is often a handicap

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to successful trading. If you can't make a profit from a $5,000 account, you probably won't make a profit from a $20,000 account. Some brokers, especially those who have convinced new traders to let the brokerage firm make all the trading decisions, will require larger deposits, giving them a greater cushion for losses and more chances for commissions. A tight string on an account you manage yourself will prevent the kind of outrageous losses reported so frequently in the business. Your success at commodity trading will depend more on the skills you perfect than on the amount of money you invest. Money does not make money in commodities. The trader makes money, and does so by precisely planned plays that are systematically executed according to a methodical plan. Beginning with a few thousand dollars, the trader (who has presumably already practiced "on paper" for some months) can comfortably stake out positions in several markets, testing the waters. At the outset the account is traded conservatively, with an eye to sheer survival. Losses are cut strictly short, profits allowed to run, until the account grows to twice or thrice its original value. Profits should then be taken out and enjoyed, the account either closed or returned to its original state, and the process begun over again. I strongly recommend that you do not put much money into the markets until you understand completely the methods of successful trading, and have done your homework in this and other texts.

      The second widely-held misconception contends that only "experts" have a chance of making profits in the dangerous game of futures trading. Common sense and the experience of hundreds of traders prove this notion false. Who is more of an "expert" about the price of potatoes, beef, pork, cooking oil, cocoa, coffee, orange juice and all the other commodities traded than today's price-conscious consumer?

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Most commodity terms and names are much more familiar to us than such stock market terms as "convertible bonds," "price/earnings ratio," or "book value." Everyone understands what is meant when it is said that the price of soybeans will fall 30s¢ at harvest when the bumper crop comes in. The laws of supply and demand still hold sway in most commodity markets. It may seem as if the factors determining prices are infinitely complicated and numerous, known only to the "insiders." The fact is that almost all the hard data comes from government agencies, in publications issued only on scheduled dates and prepared behind locked doors. Everyone has equal access to the information at the same time. And, at any given time, only three or four factors are changing enough to substantially influence a commodity's price. If the so-called "experts" or "insiders" at General Mills or Chase Manhattan could figure out the markets perfectly, they would do so, and the futures exchanges would be rendered useless, for there would be no uncertainty about future price changes. This hasn't happened, evidence enough to overthrow this old myth.

      This is not to imply that commodity trading is a lead pipe cinch or that you can't lose money when you start trading. You can! The statistics are against you, as most people come out losers. The primary reason for these losses is the lack of a successful trading method and the absence of carefully developed and patiently applied trading skills. People do not lose in the markets because they have been "outfoxed" by the "experts." They have been outfoxed by themselves, or by some trading gimmick offering instant and effortless profits. If you take the time to learn well the basic approaches involved in successful trading, you will already be well ahead of most traders.

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      This book is designed to teach you one of these approaches, and to introduce those of you, who are newcomers to the world of futures speculation. It was not designed to be a complete course in commodity trading, something you should understand from the start. What you will learn here is one simple method for buying and selling commodity futures contracts, no matter the type of commodity or the exchange involved, which exhibit a specific and identifiable price patterns. In my experience as a trader I have found this method to be the easiest, safest, and most consistently profitable system for trading commodities. No method is fool-proof. No one can guarantee you profits in the futures markets. It is for this very reason that the speculator needs a method that minimizes losses and maximizes profits. The method should also be one that is comprehensible, that can be applied by anyone of average intelligence, and which does not require dependence on a broker, advisor, or computer. The method should reduce the number of variables that go into the trading decision to the absolute minimum.

      Most important, a successful trading method lets the market make the decisions. The fastest way to lose your money in the futures game is by betting against the demonstrated trend, taking positions based on the hope, fear, or rumor of a price move. The method to be taught below begins with the first law of commodity trading: The market is always right. If the market is headed in one direction, don't fight -- switch. Winning commodity traders never try to outsmart the markets.

      Of course there are as many systems for trading as there are traders in the markets. Commodity publications, brokerage firms and advisory service brochures advertise everything from the most sophisticated computer analysis to astrological forecasts of price cycles. Some traders "buy hogs before the holidays" or "sell wheat before the harvest."

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Your order to buy or sell is executed at the commodity exchange pit or ring. Floor traders and brokers must make all trades by open public outcry, creating a genuine free market in futures contracts.

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Some are disaster traders who buy and sell on the news of floods, droughts, famines, strikes, freezes or other disturbing events. Many traders wait to see what others will do, then hop aboard the bandwagon. Those who trade primarily with an eye on the factors of supply and demand are called "fundamentalists" by books on futures trading. Those who put little stock in such computations and trade instead according to the market's own price history and recent behavior are called "technicians." Most methods combine the two, but with a decided preference one way or the other.

      Analysis of the fundamentals works chiefly for the forecasting of long range price moves. Fundamentals can establish the general frame of reference for particular changes in a commodity's price. But having a good idea of which direction prices should go, and why, doesn't help much if prices go the other way. Nor is it of great assistance even if the favorable move occurs, for then the trader still must evaluate the condition of the futures market and decide the best way to trade it profitably. The successful speculator cannot afford to be ignorant of the fundamentals, but the real test of skill comes in learning to trade the movements of prices as they really occur.

      One key distinction ought to be kept in mind. The speculator trades prices, not physical objects. The speculator wants to buy low and sell high. It is the movement of a commodity's price that offers the potential for profits, not the commodity itself. If wheat prices sit dormant, move over to cattle or corn. Your main task is to spot the kind of movement in the price of a commodity that can return you hefty percentages of your initial outlay. The method taught in this book performs that task. The trader will learn to spot one very obvious and particular price pattern. Once spotted, that pattern gives the "signals" for when and where to buy and sell

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futures contracts in the commodity concerned. Many patterns have been described in the analysis of price swings. The pattern I have chosen as the foundation for the method is one that appears frequently, one that has in fact been seen in almost every commodity traded during the last ten years. It is a simple pattern to trade, one offering the trader a reasonable chance for substantial profit while exposing invested funds to a logical, moderate risk.

      There are certain tools you will need to use this method of trading. Since you are trading price moves, you will need daily price quotations for the commodity futures contracts you wish to trade. Most large newspapers give a daily table of the previous day's price activity on the principal exchanges. National publications like the Wall Street Journal and the New York Journal of Commerce are excellent sources for futures prices. Or if convenient, just call or stop by your broker's office for a free, up?to?the?minute report on price activity.

      If you've never read or followed futures prices before, study the sample below for a minute:

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This quotation would reflect the previous day's trading. The left hand column lists each of the contract months currently trading. The "May" contract opened that day at a price of 2.74½ per bushel. "High" and "Low" tell the extremes reached by the contract's price during the day's session. "Settle" gives the price at the close of trading. "Change" specifies the net difference from the close of the previous day's trade. "Lifetime High/Low" represents the highest and the lowest prices hit by the contract since the first day it began trading. "Open Interest" denotes the number of open, held contracts in the contract month as of the close of the previous day's trade. "Est. vol." represents the estimated volume of trades, both purchases and sales, in all corn contracts for the day.

      The second tool for trading you will need is graph paper, on which to record and chart the changes in price. Once your system is organized and in place, it will take surprisingly little time to keep it up?dated. But be ready to commit that time, to keep up with the markets, and to watch for opportunities. If it seems bothersome or wearying at first, just calculate what your per hour salary works out to after your first winning trades!

      What is the purpose of all these graphs? The trader needs a picture of the recent price action. In order to see the pattern prices are falling into, a visual display is constructed on paper that corresponds to the actual movement of prices and which dictates how best to position oneself for the future. The chart will show the market reality, the pattern of ups and downs, the trends and the ranges. On a chart you can see where prices have been, and be set to profit wherever they are going. The chart gives you a simple way to see how to position yourself in relation to price moves, where to get into a market, where to get out, when to do either and when to do neither.

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      Constructing a price chart is an easy procedure. On your graph paper, darken one of the vertical lines near the edge of the paper. From the base of this line, darken one of the graph paper's horizontal lines and extend it across the page. The vertical line will be your price axis. Each step will represent a unit change in the commodity's price. The horizontal line will be your time axis. Each step across will represent weeks, or months, or years.

      The sample chart at the right shows fluctuations in wheat prices from June to January, at two week intervals. It is immediately apparent that this commodity's prices underwent some volatile movement, and that there were plenty of opportunities to profit for those traders who knew how to spot the patterns. Obviously the sensitivity of the chart to price changes, and the detail with which it will show price patterns, depends upon the size of the price and time increments used in its construction. Time spans greater than a month do not have enough precision; charts showing hourly price changes have too much precision. Most of the charts used in this book's illustrations record daily high, low, and settlement prices, with each darkened vertical line marking the end of another week. Remember when comparing price charts to gauge the significance of price moves; always take into account the size of both the time and price increments. The severity of a price pattern can be smoothed out or exaggerated by manipulation of these increments. If the sample price chart had been drawn with price increments of 40 instead of 20, the result would have implied a far less volatile market. To check the significance of a price pattern, calculate how much could have been lost or won by a trader holding a contract for a day, a week, or a month.

      For example, take a look at the charts for the December and February Hog contracts on the following pages:

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