Things You Should Know About Trading Commodities

 

The fundamental fact about commodities that all players must reckon with: Incredible volatility. The fluctuation per day averages about 1%. Multiplied by a leverage factor of 20, the trader can anticipate at least a 20% profit or loss per day. It's hard to have the stomach to cope with these losses or gains in a businesslike fashion. But anyone who actively trades tangibles (gold, diamonds, paintings, or antiques) is probably a good candidate for commodities

Comparison to the stock market: The aggregate value in commodities is much larger than the stock market. And the dynamics are much greater. Result: Money is made and lost faster And there are many more pitfalls.

 

Please check A Quick Course on Convertible Bonds.

In the stock market, you can lose money in bits and pieces. You don't realize a loss until you sell out your position. Capital invested in the commodities market is all at risk. You don't have to place a buy or sell order to win or lose. Money is credited to your account if your position is right. If it's wrong, the broker tells you how much you owe.

An old saying in the commodities market You never make money from the market; the market only lends you money until it takes it back from you. It's probably true. And so is the estimate that 95% of the investors in commodities lose money. Although the commodity exchanges have arbitrary limits governing how much prices can rise and fall daily, investors can lose much more than they initially put up. We previously wrote: Buying Treasury Bills: An Advice.

For beginners: Brokerage houses will let you put up as little as $50,000 for an individual commodities trading account. There are also managed group accounts for people who are ready to put at risk only $10,000-$20,000 Caution: A few of these groups have good records, but most are only a couple of years old. Results are not sufficient to evaluate them.

Making an emotional move is the most common speculators hurt. market is so volatile and moves so fast that an investor is, in effect, constantly making a buy or sell decision. And the leverage is so great that a move of a few cents means a few thousand dollars.

Investors must: Expect to make wrong decisions that could cost a great deal of money. Set a time horizon once a decision is made, and stick to it.

General rule: With leverage so high, you may expect to win or lose 25% of capital on any day. Problem: When you are making and losing such large sums you forget one of the basic principles of running a business: Recognize the real costs.

The average holding in commodities is only four or five days. A $60 commission every time you make a move can mean thousands of dollars in commissions a year that wipes out a good part of your gain.

The difference between the bid and asked prices for a commodity can run three times the commission cost. Result: When you get in to a commodity you are frequently already down 20%.

Human frailties are likely to emerge in commodities trading. Reason: People get excited about making a lot of money, due to the volatility Professionals recognize that the chief effect of volatility is to relieve the public of the maximum amount of money in the minimum amount of time.

The Psychology of Trading:

Movements during the day play on the emotions. If you are wrong, you have to adopt a very unemotional attitude toward the loss The worst thing to do: Keep calling your broker all day.

Have the moral fiber to stay with your conviction. The average trader must increase the time horizon for holding a contract 15-fold before getting the chance to make a profit. Example: Instead of trading every three or four days, hold on to the contract for 50 days. That gives you a saving on commissions and the bid/asked penalties.

Worst mistake of all: 

 

Doubling up after a gain or loss. When you do this just a small loss will wipe you out.

Looking for bargains is a mistake in the commodities market. When prices drop. don't buy. It is better to short when things start to look cheap.

Strategy for outsiders: 

 

Don't convince yourself that you can read the daily financial pages and get sufficient insight into commodities. You are trading against experts who know the number of freight-car loading in Peru and the hourly temperatures in Russia. Whatever insight you have probably won't be superior to theirs.

Exception: 

 

If you are in a business where you are sensitive to certain trends (like the im pact of a fall in sugar prices on the candy business), your understanding may be of value in a long-term time frame.

Personal knowledge gives you a realistic outlook that helps you invest in commodities. If this is the case: Consider at least a six-month horizon in which you want to move. Don't put up a minimum margin. Put up 15% in stead of the required 5%. Plan on maintaining your position.

 

You may be wondering How a Professional Investor Handles His Own Money, read it.

Fundamental impact of interest rates on commodities: When rates are high, everything else goes down. Investors lose sight of this, be cause when rates are high everything is usually booming. They forget that a disaster could just be around the corner. If you are long when interest rates are high, you will get wiped out. Go against short-term trends and with long-term trends. Example: If soybeans have gone down 15% in a month and up 3% the last week, don't buy. Sell short!

Source: Victor Niederhoffer, chairman, Niederhoffer, Cross & Zeckhauser, Inc., a merger and  aquisitions firm that specializes in selling companies in the $2 million to $25 million range, 49 W. 57 St, New York 10019.