How to Make Money in Commodities

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years of commodity futures trading has convinced me that the "breakout from a narrow range" pattern offers more profits, more often, and with less risk than any other. It is a pattern that returns, because of the ongoing force of the breakout, substantial profits to those who wait patiently and then climb aboard. The speculator in December Wheat who bought at $3.50 and sold at $5.00 would have made $7,500 (minus commissions) in just two months, a profit of 500 percent on the required margin of $1,500.

      Waiting for a commodity's price to actually make its move out of the old sideways channel eliminates much of the danger one can run into when playing the markets by a price forecasting method. The uncertainties of price forecasting, and of trading on the basis of such forecasts, have been exhibited countless times (to the ruin of many speculators). In 1963, it was rumored in financial circles that the United States government would stop selling silver from its treasury stocks. Economists forecast that, when the government sales halted, the demand for silver would be so great and the supply so small that the price of silver would jump from its 1963 average of $1.25 per troy ounce to above $2.00. Commodity futures traders who understood Principle #1 knew that when the cash price of silver rose, the value of silver futures contracts would also rise. So, in 1963, traders throughout the world bought futures contracts for silver. Expecting a substantial price rise, they bought and they bought and they bought.

      But the United States government didn't stop selling silver from its stocks in 1963, and the price didn't rise to $2.00 an ounce. It rose a little, to $1.29, and then sat there. In 1964, rumors once more forecast a cutoff of government silver supplies, exciting more traders to buy silver. The rumors were just that -- rumors. The forecasts were wrong, and silver closed the year where it began, at $1.29. The same story

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repeated itself in 1965 and 1966. The traders who had bought silver futures watched their money sit dormant, or took small profits and losses while waiting for the big move.

      The successful speculator, however, stood apart from this crowd. This trader also knew that the cash price of silver would take the futures price with it, and believed that a halt in government sales would drive silver prices up substantially. But, unlike the thousands of other silver traders, this speculator knew better than to bet money on a belief. Charts and careful planning were substituted for forecasts, rumors, and hopes. When and if silver prices rose to $2.00, they would have to pass through $1.35 to get there. Silver futures hadn't broken that level for years, so it was reasonable to assume that a move through this barrier signalled a strong uptrend. So, rather than just hoping for a price advance in silver, the trader decided to buy futures contracts only if prices actually did rise. This trader, being a wise investor and methodical speculator, called the brokerage house and gave one simple order:

"Buy 10 silver contracts for me at $1.35 an ounce Stop/GTC."

      This kind of order is called a "stop order." It instructs the broker to buy 10 silver futures contracts for the trader if, and only if, the price rises to $1.35. If the price does hit $1.35, the "floor broker" or "pit trader" at the exchange who is charged with executing the speculator's order will now treat it as a "market order," filling it at the best price available. But if the price never rises to $1.35, then no trade is executed and no contracts purchased. A "stop order" is activated only if the specified price is hit. The trader could have placed this order in 1963 and just let it sit, "GTC," good?till?cancelled. No

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Don't bet on rumors, fears or hopes. Make your trades only when the market actually starts to move.

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commission is charged unless the order is actually executed. For four years the order sat. The trader kept out of a profitless market, yet was stationed for quick entry when the move came. No risk capital was tied up in mere hopes.

      This trader could withstand the pressure of rumors, professional advice or broker's recommendations because of strict adherence to the principles of successful futures trading:

PRINCIPLE #3: Since futures prices follow cash prices, never buy commodity futures contracts unless you anticipate an advance in cash prices. Never sell commodity futures contracts unless you anticipate a decline in cash prices.

Yet Principle #3 won't be of any help at all, as the case of the silver market shows, without a further rule:

PRINCIPLE #4: If you do decide to buy, don't buy until prices actually do advance. If you do decide to sell, don't sell until prices actually do decline.

Mark Twain once wrote:

A cat, having sat upon a hot stove lid, will not sit upon such again .... but then neither will he sit on a cold stove lid either.

By 1967 many silver traders were like Twain's cat. They had been burned by an inactive market. Tired of wasting their money and discouraged about the possibility of the big move in silver, most had left the market and turned to corn, or cotton, or soybeans. The wise speculator, however, at no cost in money or patience, kept renewing the "stop order." Finally, on May 18, 1967, the Treasury Department suddenly called a press conference in Washington to make a hurried announcement:

Gentlemen and ladies, we wish to advise the press and financial community that as of 5:00 p.m. today, the United States Treasury will cease all sales of silver except to domestic users.

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That was all the spokesperson said, but it was enough, as a look back at the silver futures chart reveals. The price of silver in both the cash and futures markets ascended dramatically. As it pushed through the $1.35 level, the "stop order" of our trader was "tripped," and the 10 contracts purchased (the actual price paid will vary, up or down, according to conditions in the trading pit itself). Then the successful trader watched gleefully as the price continued climbing past $2.00 until it peaked at $2.60.

      Then, as is inevitable with any price move, the reversal set in. Since prices were now well above the trader's $2.00 goal, and since previous reversals showed some weakness in this bull market, the trader decided to liquidate. Since prices were actually going down, it was time to sell. When price hit $2.30, the speculator called the broker and said "Sell 10 silver contracts `at the market.' " This order would be executed immediately by the floor trader at the best price available in the market.

      Let us say that the contracts were purchased at $1.35, and sold at $2.25. At that time and for that silver contract (different from today's), the required capital investment would have been $9,000. The realized profit on the total ten contracts would have been $135,000 -- a return of 1,500% in less than 8 months time. How long would it take to make such a return if the money had been placed in a passbook savings account? About 200 years!

      What you have just seen is a glinrpe into one method for trading in the commodity futures markets. (I have written about others in my more detailed Manual.) Don't be fooled by the fact that the silver trade I have described took place in the 1960s. The year or the type of commodity doesn't matter. The principles hold true, and are all the more impressive for having worked, year in and year out, on countless markets.

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Each year commodity prices fluctuate between highs and lows. Often the profit can be as unbelievably large as you have just seen. Large returns are not offered every year in every commodity. But large price moves in the pattern we have isolated do occur each year in some particular commodity, on some commodity exchange, at some time. That is one reason why the trader will want to keep an eye, and a chart, on several markets, while waiting for a profitable trading opportunity to reveal itself. What is required are four basic skills:

1. Learn to identify price patterns where price has remained in a narrow trading range for a significant period of time, and then advanced or declined markedly out of that narrow channel.

2. Learn when to buy, and when to sell, in response to such market moves. Learn to use "stop-orders."

3. Learn the technique for protecting your futures position and conserving your profits. As we shall soon see, the skillful use of "stop-loss" orders will generally enable you to get out of the market with a manageable loss should the market price move adversely in relation to your position.

4. Learn the technique for letting your profits run, maximizing returns should your futures positions be on the right side of a price move.

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SECTION TWO

THE METHOD AND THE MARKETS

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II

      Commodity futures is a high?speed, high?risk, highreward marketplace. New contract months begin trading as soon as the old expire. New individual contracts come and go, sometimes in seconds, as traders establish or liquidate positions. If you miss a price move in a commodity, don't worry. There will always be another chance soon, in one commodity or another. As long as prices fluctuate, there will be traders willing to buy and sell for a profit. The successful trader plans to go where prices go, when they go, keeping the trading ship afloat and sailing even as the winds and waves toss all around. A profitable voyage comes from the skillful exploitation of forces which, if one were to resist them or play them wrong, can quickly sink the most expensively outfitted investment vehicle.

      We left you at the end of the first section of this book with a list of four basic skills required of successful futures traders. These skills, it was asserted, are equally applicable no matter what the commodity traded -- wheat, soybean oil, T-Bonds or silver. The substance doesn't affect the method. Why? Because prices for a product can only go one of three ways: up, down, or sideways. There are no other choices. The method you are now learning is designed to profit from a commodity which first goes sideways for a significant period of time and then advances or declines out of that sideways price trend. It is as simple as that.

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Do these volitile markets qualify for method trading?

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      We found that three steps were necessary elements in the method of our trading program. First, collection of commodity futures prices on a regular and steady basis. Second, accurate and up?to?date recording of prices for commodities the speculator is interested in trading. Third, transfer of daily price quotations from these records to a piece of graph paper in order to better visualize price histories and trends. Such charts enable the trader to determine, at a glance, the direction of prices -- up, down, or sideways. (Professional charts, such as all those used in this text, may be purchased from a number of subscription chart services.) Learn to use these tools, through practice and patience, and you'll be on your way to creating your own independent system for successful trading.

      Where do you start with your newly acquired tools? First, learn to spot the kind of market that qualifies for trading according to the method. Not every market qualifies. The trader should be able to recognize profitable markets with a short glance at the charts. On the preceding and following pages are some typical commodity futures price graphs of the type we have been discussing. You could have maintained such graphs on your own using daily prices out of the newspaper, or received them through subscription to a service. Either way, the charts tell you where the market has been, where it stands, and where it is likely to be headed. Examine the charts for September Plywood and October Live Cattle. Do these contracts, according to the charts, qualify for trading with the method we have been learning? Are prices in these graphs fluctuating in a narrow range over a long period of time? Clearly they are not. Fluctuation in a narrow price range should be the first characteristic the speculator checks for on the chart.

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