Most Important Attributes of Successful Commodities Traders


Trading commodities in the futures markets are not for the faint of heart. The fact is that commodities futures and options are perhaps the most volatility asset class when compared with equities, bonds, and currencies. Leverage in futures and options on futures exacerbates the volatility of results as margin requirements on futures tends to be less than 10 percent of total contract value. Therefore, for $1 a trader or investor can control $10 or more worth of an underlying commodity.

When it comes to trading or investing in volatile assets like commodities, there are some very important issues to keep in mind. Trading in the commodities market is not for everyone. Those who approach these markets tend to look for greater rewards. With a greater opportunity for profits, there is always a higher potential for losses. There is no free lunch in markets and reward is always a function of risk.

There are some attributes that many successful commodities traders have in common. For those looking to get involved in commodities markets, it is important to understand the trademark characteristics of those who succeed.

Become an Expert in Futures and Options

Perhaps the most important exercise for those considering investing or trading in the futures and options markets is to spend lots of time learn the ins and outs of futures and the exchanges that offer these financial products.

There are so many different commodities and financial products that trade on the two major commodity exchanges in the United States, the Chicago Mercantile Exchange (CME) and the Intercontinental Exchange (ICE). Each of these exchanges offers a tremendous amount of material for those who wish to educate themselves.

One of the most important areas to begin is with the concept of margin. Margin is a good faith deposit required by exchanges to enter into long or short positions in the products they offer for trading. It is also critical to understand all of the contract specifications for the markets that you are considering. Each market has different characteristics. For example, a gold contract that trades on the COMEX division of the CME represents 100 troy ounces of the yellow metal while a silver contract represents 1,000 ounces. An oil contract that trades on the NYMEX division of the CME represents 1,000 barrels of the energy commodity while a natural gas contract represents 10,000 MMBtu’s or 10,000 million British Thermal Units of gas. Sugar that trades on the ICE exchange represents 112,000 pounds while a contract of coffee contains 37,500 pounds.

Some commodities trade for all months throughout the year while others trade for specific months set by the exchange. Each contract has a different minimum tick value which represents the financial results of a minimum unit price change. Additionally, many commodity futures have different specifications when it comes to making or taking physical delivery of the underlying commodity while others offer only financial settlement for long and short positions upon expiration of the futures contract.

Each commodity has a set of idiosyncratic attributes so it is important to understand exactly what a trader or investor is buying or selling before entering into these markets. The exchanges offer lots of information on price, volume and open interest when it comes to each of the contracts they offer and it is important to understand this data and use it when analyzing and understands these markets. Additionally, select a trading platform that is comfortable, understandable and offers the services you require for your specific trading and investment activities.

Understand the Fundamentals

One you understand how the futures and options work on the exchange, understanding the fundamentals or supply and demand characteristics of these raw material markets is of primary importance. Fundamental analysts tend to research total supply versus total demand in markets at different points in time.

Fundamentals are the economics of commodity markets. When current supplies exceed current demand, a market tends to be in an oversupplied condition and the path of least resistance for prices can be lower. When current demand exceeds current supplies, prices tend to move higher.

Commodities are economic trading vehicles. Prices tend to fall to a level where producers cut output and inventories begin to decline. At this point in the cycle, lower prices begin to attract demand from consumers at which point the price finds a bottom and begin to move higher. When the price rises and reaches a level where producers increase output, consumer demand tends to decline and inventories build at which point the price tends to reach a peak and the cycle begins all over again. Fundamental analysis is an attempt to understand the cyclical nature of a commodity market through the use of supply and demand data.

Understand the Technical Factors

Technicians study the herd behavior of prices in commodity markets by using historical price trends to predict the future trend. A technician uses a chart or picture of price movements over time. Some technicians look at very short term price data, sometimes as short as within a trading day, while others look at longer-term data such as daily, weekly, monthly or longer to understand price behavior.

Market prices go higher when there are more buyers than sellers and they go lower then sellers overwhelm buying. Therefore, technical analysis is an important component to understanding the current path of least resistance for prices and predicting the future.

Technical analysts attempt to identify price patterns on charts that will cause others in a market to buy or sell. These price patterns often create self-fulfilling prophecies that move price, particularly over the short-term, and create profitable opportunities for nimble traders and investors who identify the pattern and take advantage of the price action that follows.

Data available from exchanges when it comes to volume and open interest often helps the technical analyst measure strength and momentum of emerging or current price trends.

Disciple Is critical

One of the most important attributes of a successful commodities futures and futures option trader or investor is discipline. Discipline is the process of establishing a plan and sticking to that course when it comes to taking a long or short position in a commodities market. One of the most important rules is to set your horizons for a desired profit on a position as a function of the potential for a loss. Setting the risk-reward profile of a trade is a critical process. One of the golden rules of trading is to never risk more on any one trade that you are looking to make. Additionally, a successful trader never puts all of the eggs in one basket. In other words, one should never risk the majority of trading or investing capital on one trade.

I have never met any trader or investor that always gets every trade right. In fact, most of the successful traders in the world have only a 50 percent record of calling the market direction correctly. However, these profitable traders tend to adjust risk reward so that they stop out of long and short positions they get wrong and ride the positions when they are right to optimize profitability. The use of stops is not only for losing positions. Many successful traders will use a stop to protect capital and profits on positions that are profitable.

A combination of fundamental and technical analysis used with a disciplined approach to markets can create the optimal approach to the commodities futures and options markets.

Other Commodity Products Outside the World of Futures Exchanges

Over recent years, the advent of ETF and ETN products that replicate the price performance of commodities that trade on the exchanges have become available to investors and traders who only have accounts in the equity markets. While knowledge about futures exchanges is not necessary when trading or investing in these market vehicles, fundamental, technical, and the principals of discipline still hold true when it comes to a successful approach to the ETF and ETN markets in commodities. Additionally, for those that chose leveraged ETF and ETN vehicles understanding the risks by closely studying the prospectuses of these market instruments is a critical requirement for success and avoiding many pitfalls.