How To Trade Commodities Futures – The words below completely changed my view of the markets. I want to share this with you with the utmost respect for the legendary Larry Williams – my dear mentor.
“… Sounds simple; there are only three approaches to trading commodities. But it’s true. There are only three different approaches to predicting or understanding future commodity price movements. Of course, there can be many levels of complexity within each of these approaches or strategies.
How To Trade Commodities Futures
First, we’ll talk about the three approaches, and then we’ll delve into the complexities of knowing the future. Analysts or traders when trying to figure out whether to be long or short or no positions will rely on one of the following techniques:
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This is the art of looking at charts, indicators and just about everything to do with price action. The theory is that “the market knows everything and this is reflected in the last price”. So, if you understand price movements, you can predict what will happen in the market. This is how the vast majority of speculative traders approach this business.
These charts, oscillators, indicators, moving averages and a host of other techniques and tools are believed to predict the future. This is popular because it’s easy to look at charts and get some sort of idea. Credit Suisse, a major financial bank and stronghold based in Zurich, uses technical analysis and describes it as: “Technical analysis is the study of how the financial market works. A technician observes price changes that occur from day to day or week to week or any other constant time frame shown in graph form, called charts. Hence the analysis of the name chart.”
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A chartist only looks at price charts, while a technical analyst studies technical indicators derived from price changes in addition to price charts. Technical analysts look at price action in financial markets rather than the fundamental factors that (appear to) influence market prices. Technicians believe that even if all the relevant information about a particular market or stock were available, you would still not be able to predict the market’s accurate ‘response’ to that information. There are so many factors interacting at any given time that it’s easy to overlook the important ones in favor of what’s considered the flavor of the day.
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A technical analyst believes that all relevant market information is reflected (or discounted) in the price, with the exception of shocking news such as natural disasters or force majeure. However, these factors are quickly ruled out. Looking at the financial markets, it becomes evident that there are trends, impulses and patterns that repeat themselves over time, not in exactly the same way, but in a similar way.
The charts are self-similar because they show the same fractal structure (a fractal is a tiny pattern; self-similar means the general pattern consists of smaller versions of the same pattern), whether stocks, commodities, currencies, bonds. A chart is a mirror of crowd sentiment, not fundamental factors.” Thus, technical analysis is the analysis of the psychology of the human mass.
Here we have the art of studying the production and consumption of goods. Fundamental analysts will study crop reports to find out how much was produced, the government says. They often go out into their fields to get an idea of whether the production of wheat or corn or gold or silver is relatively high or low. In fact, there are only two sides to fundamental analysis – production and consumption of goods. Most of the basic data refer to the production side.
The US Department of Agriculture and the Commodity Trading Commission publish periodic reports that update agricultural production. We get planting intentions, which tell us which crops and how much farmers are going to plant. Things of that nature are on the production side.
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“The road to hell is paved with good intentions.” In this business, planting intentions have to deal with Mother Nature. We can have droughts, very cold weather, a lot of rain or little rain. It has been said that the world’s great speculators are our farmers because they are always subject to the whims of Mother Nature.
In terms of consumption, we have to look at usage and trade-offs. In a booming economy, copper will be used much more than in a depression. When times are tough, people eat more chicken and cheaper pork than more expensive beef. Thus, there is always a trade-off between consumers switching from one item to another if it is possible to substitute one for the other.
In addition, there is an inside view of commodity market fundamentals, looking at price differences between close contracts and short contracts in the distant future. Traditionally, close contracts are sold for less money than long distance contracts. This is called an assistance allowance. After all, a person who is going to buy or deliver goods six months from now has costs involved; storage, interest, insurance, etc.
However, this can sometimes change. The changes are significant. If the difference between the near contract and the far contract decreases or becomes really positive, this tells us that someone wants the near contract so much that they are willing to pay more for it than usual.
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I have news for you… That person is not me and it is not you. These are big business users. So we can follow their trail in the market and get information about what they think is fundamentally happening in the natural resource markets.
Another tool I use is to look at the relationship between any commodity and the price of gold. My belief is that gold represents a store of value… Let’s call it unity. So we can see how much the commodity is above or below the gold price unit. When it is far above the price of gold, the price of the commodity is likely to fall. When the price is far below the price of gold, the price is more likely to go up.
As you can see, this is not a map reading. This is an observation of the fundamental situations that exist in the market. Thus, fundamental analysis is an analysis of the law of supply and demand.
I combine technical analysis with fundamental analysis. Because both are important. I don’t think anyone has all the keys to the realm of wealth. It is very easy to be a technical analyst. All data is in your graphs. And it’s not so easy to be a fundamentalist analyst. Data is difficult to collect, most not readily available, and often difficult to digest or understand. But it exists and it is extremely important.
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I must say, ‘Charts don’t drive the market, conditions drive the market.’ To which I also emphasize that just because the market is conditionally ready for recovery does not mean that the time has yet come. For me, this is where technical analysis comes in to help us identify that the market has reversed the trend and is now set to recover due to the underlying condition.
That’s my approach. First, I will identify the underlying market conditions that have historically occurred when markets have experienced major ups and downs. I use several tools for this; one is a merchant engagement report. One is the major fundamental value linking the price of commodities to gold. Others are seasonal influences, cyclical influences and various other indicators.
I learned a lot about seasonal relationships in various commodities… They are there… And they work… But they don’t always work. You really need to know and understand the relationship of price to seasonal patterns. Another technique I use is to look at the current accumulation that is happening in the market. What I do is measure the amount of professional buying and selling that takes place every day. I was able to determine when the market is under professional accumulation. If this starts happening at the same time, the market is tentatively set to rally… Obviously, I’m going to take the buy signals and sell the market. Thus, I combine technical and fundamental analysis; they play each other.”
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