Two Cents Worth: Don't trade Commodities Blindly

Feb 3, 2008

Two cents'worth : Don't trade commodities blindly - have a plan
By Kevin Kerr, AUTHOR

YOU don't know where you're going unless you have a plan to get there - I truly believe that.

So many new commodities traders jump into these markets with no real plan or objective, and often they wind up out of the market just as fast as they got in.

It's vital for every trader to have a well thought-out and concise trading plan in order to succeed. The short time it takes to sit down and write out a well thought-out trading plan pays for itself over and over again. I'm proof of that.

A trading plan should include your basis for trading that particular commodity in the first place. For example: I'm buying orange juice because I believe there'll be a hard freeze this winter and juice prices will go higher. It can be as simple as that.

But to back up my trade in orange juice, I would also investigate the crop condition and the overall global demand. Then I would turn to my technical charts and see where support and resistance are for the juice and how much open interest there is. If all of these things supported my trading decision, then I would proceed.

Futures are called 'futures' for a reason ....time! In futures and options we're always keeping an eye on Father Time, tick, tock, tick, tock. Options prices are strongly based on how much time value is left in a particular option. As that option comes closer to expiration, the time value decays daily, eroding the option's value. Both futures and options expire when their time runs out, so it's vital to pay close attention to time.

As traders, we need to decide whether we want a longer-term trade or a shorter-term trade. As I've said, I typically like to trade futures with at least three full months to expiration, because I want the trade to have time to develop.

On the longer-term trade, I go no more than 18 months, because any further out, the market becomes too illiquid. Examine each trade individually to figure out the merits of trading it longer term or shorter.

Say I believe that corn is in a long-term bull market as a result of ethanol demand, and even though (for the sake of argument) corn is abundant right now, in 18 months from now, it may not be so; so I would buy futures expiring 18 months from now, hoping for a big move upward.

Alternatively, if I thought that the Federal Reserve was planning to raise rates, I might sell gold short on a short-term basis, of say, three months. You get the idea.

Excerpted from Kevin Kerr's A Maniac Commodity Trader's Guide to Making A Fortune, published by John Wiley & Sons.