Trend Following in Commodities Trading

Follow the Commodities Trend

516214465.jpg

“The trend is your friend.” That is a statement that has been circulating among commodity traders for a long time. It simply means that you should trade with the trend of the market to increase your chances of success.

What is a Trend in Commodity Trading?

A trend means that prices are steadily moving higher or lower over a period of time. It is consider an uptrend if prices are rising over time. It is considered a downtrend if prices are declining over a period of time.

The reasoning behind following the trend is that prices are more likely to continue in that same direction than reverse. You put the odds much more in your favor by trading this way. Many professional money managers trade with a trend-following philosophy and many commodity trading systems are built around trend-following formulas.

The Turtles

Proof that trend following works can be found in the story of the Turtles. In 1984, a very successful futures trader named Richard Dennis had a bet with another trader William Eckhardt on whether he could give a group of individuals a simple set of trading rules that would make them successful traders. The trading rules consisted of a trend following system and simple money management skills. It turned out that the experiment was an amazing success and some of the students went on to pursue trading careers. The Turtle Trader has a great deal of valuable information on trend following.

Tips on Following the Trend

You never know how high or low a market is going to move. Therefore, if you are following trends, you are likely to catch some very profitable moves in the commodity markets.

There are two common way to enter the markets when you spot a trend:

  • Buy on a pullback. If the market has been moving higher for ten days in a row, wait for a 2-3 day where prices decline and then buy.
  • Buy when the market makes new highs. You will never miss entering trend that way. This is the hardest thing for many traders to do, that is why it is one of the most successful techniques.

Remember that trends don’t last forever. You still have to control your risk and protect your profits.

Update by Andrew Hecht May 19, 2016

There is another old saying in the market, and it goes something like this, follow the trend until it bends. When it bends, a market reverses.

Trends are important when trading on a short, medium or long-term basis in any market and commodities are no exceptions. There are a couple of things to remember when trying to assess if a trend is strong or weak. I like to use volume and open interest data to validate the strength of a trend. Volume is the total number of futures contracts that trade. Open interest is the total number of open long and short positions on a futures contract. Volume and open interest data are available on most market platforms, and exchanges like the CME and ICE publish this data each day on their websites. The CFTC also puts out the commitment of traders data on a weekly basis. There are a couple of simple rules to follow when it comes to volume and open interest.

When the price of a commodity rises or falls, rising volume and open interest accompanying the price move validate the move and direction. It tells us that and that the price activity is attracting more market participation. Rising volume and open interest are a sign that a trend is likely to continue. Conversely, when a price rises or falls, and lower volume and declining open interest accompany the move, it means that market participants are retreating from the market. Falling volume and open interest are a sign that a trend is running out of steam and could reverse.

There are so many factors that influence commodity prices and volume and open interest are just two of many metrics to watch when trading in the futures market. However, these two tools can be useful as they tell us a great deal about herd mentality and market consensus.