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Phantom of the Pits
by Art Simpson

Chapter 4 - Preparation for Trading





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When several traders who use the Futures Magazine traders forum learned that there would be a book on Phantom of the Pits they made suggestions. We are going to start this chapter according to Ulrich Eckardt, a young trader who was born around the time Phantom was learning his first behavior modification about trading.

When Ulrich was in the States as a youngster, his uncle wanted him to paint the stove pipes on his roof. Excited as any child at a young age to earn money he was eager to start. He grabbed the paint and a brush and decided to hurry on the roof.

His uncle stopped him and gave him his first lesson in trading or life for that matter. His uncle proceeded to tell him the requirements of completing a job. First you must be properly prepared. Second you will do the work and last you will do the clean up.

It seems we can follow that train of thought just fine. First we must be prepared!

ALS - It's a step everyone must go through to get to where traders want to be in trading. To prepare oneself for trading is just as important as any aspect. Without it a trader does not have the foundation to continue in trading. Where does a trader start to prepare to be a successful trader?

POP - Too many beginning traders and established traders take the easy route and expect the markets to be cut and dry of what is required of them in their trading careers. They will paper trade and have fairly good success. This in no way prepares them for trading.

They must be prepared in every way. That means mentally as well as physically and emotionally. Priorities must be in the proper place including family, friends and environments.

ALS - Where do you suggest they begin?

POP - Get your office ready! Pick out your office where it is comfortable for you to have quiet time and a proper place to relax. Trading is going to be an all out effort if they expect to climb the mountain in front of them.

The first thing is to get a comfortable chair. It must be a proper chair in order to start behavior modification immediately.

ALS -(laughing) I really have heard strange things but really? The readers are going to think this is a Joke book! A chair?

POP - I'll tell you the reason for that remark about the chair being so important. There is significance in what I am going to tell you about the proper chair. You see some traders think that the market is to position and lean back and wait to get stopped out or take their winnings. It's not. That is where your chair is going to save you more than it cost you.

Don't get one of the lean back easy chairs as they will be too comfortable and like the markets, you must be reminded daily that you can never let yourself get too comfortable in your market positions. Don't get a standard rocker, especially if you have a cat with a long tail, as it moves all over the place. What kind of chair do you think I am talking about?

ALS - I'm suppose to ask the questions! I know your chairs that is an easy one to answer.

POP - Ok, I'll give you the answer anyway. You want to get what is known as a slider-rocker chair. One that rocks back-n-forth over its own base without moving over the floor. Even get yourself an ottoman. The big reasons are as follows: First in your trading career you will find that the markets go back and forth without going anywhere a lot of the time.

Your slider rocker chair will remind you of this every time you use it. That step is important to drill into your thinking. Your chair will not move around the room but rock back and forth. Second in your trading you will find you do not ever control the market but only your position. Your chair is the same way as you can stop your position wherever you wish.

I want you to drill that into your thinking also. I will repeat what I just said because it is important. You can stop your position wherever YOU want! You wouldn't think of letting the chair oscillate if you didn't want it too. Same in trading. You can stop the markets oscillation any time you wish. Simply stop (remove) your position.

ALS - I knew you had a good reason for the proper chair. Do you really believe this helps?

POP - How much easier can it be? No one has to remind you to stop your chair from rocking back and forth. You will do it without thinking. Your trading position will often times need to be stopped. It must become second nature to automatically do it at times. This simple symbolic gesture for your office will save you lots of distress in your trading.

Note: Shortly after the part about the chair was written and permission from Ulrich Eckardt to post the draft he sent the following about a comfort couch he once had. It reads as follows: just thought I'd tell you a story about a very comfortable couch I used to have in my office.

It was back, when I traded the financials very actively. The DM had a strong resistance and I decided to go short. I was proven correct with about 40 ticks and was very tired. So I sat down on the couch and slowly fell into sleep.

When I woke up again, about 1 1/2 hours later, I had to find out, that resistance was broken and stops accelerated the contracts to new highs 200 points above my entry.

I don't have this very expensive couch anymore. I could have sold it, but I really needed to carry it out on my own and throw it away.

Regards - Ulrich

ALS - Ok we are now prepared with an office and a chair. What next?

POP - Next we want a clock with accurate time. A battery operated clock so you don't have to reset it often. The most important part of the clock is to get one that actually talks to you and gives you a reminder of the time by talking. Instead of looking at the clock for time it will remind you what time it is.

It's another symbolic point to start behavior modification. You see we remember things well when we associate them with something else. Memory experts will tell you this also. When the time announces you must realize that you are required to work with your positions and not let the market work on your positions.

You must always act promptly and deliberately within your plan. The clock can be used to reinforce your thinking and behavior.

ALS - Aren't you making an assumption that traders are clear to be free while the markets are open? Doesn't this leave out the poor trader who works two jobs and seldom has time to kiss his wife let alone trade your way?

POP - So it seems but No I am not making that assumption. My concern in preparing a trader to trade is to put behavior modification immediate from the beginning. The chair is to be used whenever any trading plan is developed and thought is given to what the market possibilities on your position might be.

The clock is to be there to remind you of promptness every time it announces. The office set up is to give the trader the message of importance to be in control of their positions and not delegate it to the markets. Your office is important because you must be in control. Remember we use to have our small space in the pit and what did we call it?

ALS - Your Office. We have our office with a chair and a clock. What's next?

POP - You must establish a routine in order to set up the environment of each trading day. Allow at least one hour prior to the opening of your market. In this hour you should exercise from 10 to 20 minutes. This really does keep your mind sharper. The next thing after your shower you should spend one or two minutes giving thanks to your higher power and explain what you are going to do with the funds you earn. Don't be selfish about it.

This actually gives your sub conscious a reason for being a successful trader. Last of all face the north and acknowledge you actually know which way is up. This gives you a better sense of well being by confirming to yourself that you are in total control. You will need that total control when you follow your trading plan.

ALS - Not everyone can do or would want to do as you suggested!

POP - I know! Some will be at work or on their way to their work but they can still do those things as they are in commute. It is important to acknowledge the reason for trading regardless of your situation or reason. Thirty years ago I would have thought it very strange to take these steps.

ALS - Do you do these things?

POP - Yes, in my own way I do. Every trader whether beginning or established should set up a routine to follow as I suggested. There is more benefit from it than can be seen at first thought. ALS - It all seems like a lot of work and we haven't started our learning process yet.

POP - The most important person in your trading is yourself. Take care of the minor details early and you will have your routine. It is more of a positive re-enforcement of what you are expecting from trading.

ALS - Are we ready to start yet?

POP - A couple of more items. You need to acknowledge your reason for trading each day. If you can't afford to buy the chair and the clock then you should postpone trading until you can. The reason being that you need every aspect of trading in your favor. If you do it all right there will be better times ahead.

The next thing I suggest is to get a favorite book to read. The last thing I suggest is to pick out a person who you admire most in your life for their accomplishments.

ALS - What would your favorite book be?

POP - I shall tell you of a suggestion from a very brilliant trader. His suggestion is "The Art of Warship" by Sun Tzu. The book was written about 2500 years ago, and forgotten for a long time. Since it was in Chinese, there are different translations. The best one is with a word from James Clavell. He based his noble house saga characteristics on that book.

The book discusses rules for war in ancient times, but can be translated into business-life, private relations and even trading. Sun Tzu rules have been alive for 2500 years now and still fit perfectly.

ALS - Why is a book important?

POP - On bad days instead of could-a, would-a or should-a you must expel your feelings of defeat as soon as possible because if you don't it will affect your next days trading. Read that book if just for 10 minutes. Make it a routine.

ALS - I guess I have a few things to learn myself. You said to pick out the one person who you admire most. Why? Who do you admire most?

Pop - There is a great deal to be learned from the person you admire most. You will need to understand your ability to become an admired person if only in your own mind. I have changed my most admired over the years and now that person is younger than I.

There are many reasons I admire my choice. I'll give you the most important reasons. She gives and gives of herself each and everyday. She is not selfish and she truly cares about her fellow men, women, children and all life on this planet. I admire that so much. I hold her responsible for showing me the light. She is the only Oprah I know.

ALS- Does she know you feel that way?

POP - No, but it is important to let your most admired person in your life know that they are indeed most admired. It goes right to the positive example you need in your trading life. Do it! Let them know even if there is no time for their acknowledgment. You have done your part at that point. It is good mental food.

ALS - Are we ready to start learning to trade yet?

POP - I would say that for me I am prepared now for the job.

ALS - I guess Preparation for trading is a different process than most imagine. I really thought we were going to get into the learning process of how to trade and setting up a program to trade. Are we going to get into the specific ways to trade?

POP - Keep in mind we want to guide and not give specific advise on trading. There are basic requirements which determine a winner from a loser and that is what I am after in this insight. There are as many ways to trade as there are traders but the basic fundamentals required are seldom presented to the trader.

It is important to present a plan which keeps the trader in the game over their lifetime. Let us expound on that subject in your book. We can address trading methods in detail at later writings. I have been trying to give some examples on the forum to help traders understand where I am coming from in my rules of Phantom trading.

We will answer some of their specific questions on trading later. I read a short book called "Notes to myself" several years ago and it was but a self-diary which had been published. It was a small book but it really had great insight. I liked the idea.

We can all learn from other people's insight on subjects that we are investigating. It in no way is advise but we can make our own minds up by knowing those thoughts. This is more of my purpose in answering you questions for this book. It puts the traders on a one on one basis for understanding the complexity of the markets and helps establish criteria for an overall plan with the most important points at the front of a trade program.

More often than not these simple thoughts are not used or known by most traders. It's sad that everyone feels they have a great fortune hunt in front of them and there isn't a lot of thought required in how trading actually unfolds.

What subject do you want to discuss next?

ALS - It's beginning to be a surprise to me and knowledge learned new again.

"Priorities must be in the proper place including family, friends and environments. " ---POP

 

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Commodity Futures Trading for Beginners
By Bruce Babcock




Elements of a Successful Trading Plan--Manage Risk

The final cardinal principle of trading overlays all the rest. It is Manage Risk. This is as crucial as the others because it is by managing risk that you limit losses and preserve your capital.

The most important element of managing risk is keeping losses small, which is already part of your trading plan. Never give in to fear or hope when it comes to keeping losses small. Preventing large individual losses is one of the easiest things a trader can do to maximize his chance of long-term success.

Another element of risk is the market you trade. Some markets are more volatile and more risky than others. Some markets are comparatively tame. If you have a small account, don't trade big-money, wild-swinging contracts like the S&P 500 stock index. Don't be above using the smaller-sized Mid-America contracts to keep risk in proportion to your capital. Don't feel you have to trade any market that might make a move. Emphasize risk control over achieving big profits.

The biggest risks to commodity traders come from surprise events that move the markets too quickly to exit at their pre-determined give-up point. While you can never eliminate these risks entirely, you can guard against them by advance planning. Pay attention to the risk of surprise events such as crop reports, freezes, floods, currency interventions and wars. Most of the time there is some manifestation of the potential. Don't overtrade in markets where these kinds of events are possible.

Trade in correct proportion to your capital. Have realistic expectations. Don't overtrade your account. One of the most pernicious roadblocks to success is greed. Commodity trading is attractive precisely because it is possible to make big money in a short period of time. Paradoxically, the more you try to fulfill that expectation, the less likely you are to achieve anything.

The pervasive hype that permeates the industry leads people to believe that they can achieve spectacular returns if only they try hard enough. However, risk is always commensurate with reward. The bigger the return you pursue, the bigger the risk you must take. Even assuming you are using a method that gives you a statistical edge, which almost nobody is, you must still suffer through agonizing equity drawdowns on your way to eventual success.

It is better to shoot for smaller returns to begin with until you get the hang of staying with your system through the tough periods that everyone encounters. Professional money managers are generally satisfied with consistent annual returns of twenty percent. If talented professionals should be satisfied with that, what should you be satisfied with? Surprisingly, disciplined individuals can do better. It is realistic for a good mechanical system diversified in the best markets to expect annual returns in the twenty-five to fifty percent range.
One last thing about creating a trading plan. Don't be enticed into trading options as a less risky alternative to futures. While the dollar risk of buying puts and calls may appear lower and more certain, the probability of long-term success is remote.

Experienced professional traders, such as Larry Williams, agree: "Options are a very difficult game because you have to do two things: You have to beat the market and beat the clock. Perhaps some sophisticated people can trade options. I've been trading stocks and commodities successfully for over thirty years, but I don't trade options because it's too tough."

The best way to trade options is to sell them to small speculators. That's what options professionals do. However, selling options has more risk and is more difficult than trading futures. Unless you are well-capitalized and committed to a full-time career as a professional options player, stick to futures.

Although the commodity markets appear complex from the outside, making money trading is quite simple. You use an historically proven plan that trades with the trend, cuts losses short and lets profits run. You trade your system in a carefully-selected group of markets. You start with sufficient capital and pay close attention to managing risk. Richard Dennis made his $200 million following precisely this kind of trading approach

 

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Monday December 16th 2002, 2:56 PM
ODJ CSCE Coffee Review: Up; Trade Buying Curbs Recent Slide


-- Brazilian Crop Forecast Could Be Out Thursday, Officials Say

-- CSCE Mar Holds Above 200-Day Moving Average At 60.25c
-- U.S. November Stocks Grew 31,650 Bags To 5.545 Million


By Susan Buchanan

New York, Dec. 16 (OsterDowJones) - Arabica coffee futures rose on the Coffee, Sugar & Cocoa Exchange Monday, but stayed in Friday's range, after trade and industry buying curbed a recent sell-off.

Mar settled 115 points higher at 61.25c a pound and May ended up 105 points at 63.55c.

"The trade was buying and locals got long early, but funds were selling," a floor broker said. "Funds are still liquidating and some of them are going short.

"They kept selling 10, 20 lots, and more at a time this morning," he continued. "Locals got out, but there was good trade buying at the lows.

"Mar held above the 200-day moving average of 60.25c, and we had an up day after a six-day decline."

Mar opened higher and soon rose 150 points to 61.60c. Funds sold and prices eased, but held above the unchanged level on trade and industry buying. Locals covered shorts, and Mar ended in the upper half of the range.

Futures volume was 5,977 lots. In the options ring, 3,054 calls and 1,550 puts traded. Over 650 against actuals were posted, mostly in Mar with a few in May.

"If funds are going short and Brazil's crop estimate is friendly, then they may have to cover," the floor broker said.

Brazil's new crop could be one-third to one-half less than the last giant harvest of 51.6 million bags in an upcoming forecast from the ministry of agriculture. The estimate could be released Thursday, officials said.

Minas Gerais and northern Sao Paulo, Brazil, received plenty of rain over the weekend. Northwestern Minas Gerais got 127 mm, keeping fields saturated and causing some flooding, according to Global Weather Services.

Colombia's Federation of Coffee Growers, Fedecafe, opened its first retail outlet, the Juan Valdez shop, in the Bogota airport and intends to open stores in Cartagena, Medellin and New York next year, turning the project into a franchise business.

U.S. stocks rose 31,650 bags as of Nov. 30 to 5.545 million bags from October, the Green Coffee Association reported Monday afternoon. The biggest increases were in Norfolk, Va., and Jacksonville, Fla., while New Orleans inventories fell.

U.S. companies roasted 17.480 million bags from Jan. 1 to Dec. 7, against 17.170 million in the same 2001 period, Coffee Publications Inc. reported Monday.

Funds and small speculators stood net long 20,264 lots of CSCE futures last Tuesday, while commercials were short that amount, Friday's commitments showed. Since Tuesday's cutoff, funds liquidated another chunk of their longs, however, and some funds went short.

Chart support for CSCE Mar lies at 60.50c, 60.00c, 59.50c, 59.00c and 58.40c, traders said.

The CSCE will be open on Dec. 24 and closed Dec. 25 and 26.


Settlement prices in cents/pound, dollars/metric ton
CSCE Change Range Liffe Change

Mar 61.25 up 1.15 60.50-61.60 Jan 722 up 18 May 63.55 up 1.05 62.90-64.00 Mar 740 up 17

Susan Buchanan,

 

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Le idee sul trading di Andrea Luchi, tratte dal suo sito www.materieprime.com

METODI DI TRADING: Analisi Tecnica, Analisi Fondamentale, Trading Scalare, Trading di Posizione


Molti di voi sicuramente sono a conoscenza del fatto che esistono due approcci principali al trading: l’analisi tecnica (AT) e l’analisi fondamentale (AF).


L’AT sostiene che tutto quanto c’e’ da sapere per poter indovinare la direzione del mercato e’ gia’ riflesso nel prezzo. Prendiamo il grano: all’analista tecnico non interessa leggere statistiche, studiare le previsioni sul consumo, sapere se il tempo favorira’ o meno il raccolto, scoprire se i contadini ne semineranno piu’ o meno dell’anno prima. Lui dice: tutte queste cose sono gia’ nel prezzo, a me basta studiare l’andamento del prezzo per sapere cosa succedera’ domani.


L’AF invece ritiene che determinare l’andamento del mercato siano proprio quelle cose che non interessano l’AT (consumo, export, raccolto, situazione meteorologica). L’analista fondamentale studia queste cose per prevedere il prezzo futuro della MP.

Chi ha ragione? I fatti dicono entrambi, perche’ tra i piu’ grandi traders esistenti vi sono sia seguaci della AT che della AF.
Diciamo che non esiste un unico sistema per far soldi in modo consistente. Bisogna utilizzare cio’ che e’ piu’ adatto alla propria personalita’ ed al proprio carattere, cio’ che funziona per noi. Quindi se fate i soldi con l’AT o con l’AF perche’ cambiare?

Per quel che mi riguarda, qualcosa mi dice che ha piu’ senso pensare che il prezzo delle MP sia sostanzialmente determinato da fattori fondamentali (tempo, raccolto, consumo, export ecc. ecc.). Infatti se domani viene una bella inondazione che danneggia tutto il raccolto, il prezzo schizzera’ in alto a dispetto di tutta l’AT di questo mondo. O se migliaia di industrie asiatiche smettono di comprare rame il prezzo di quest’ultimo calera’ inevitabilmente.


Il problema dell’AF e che essa sicuramente funziona nel lungo periodo, ma nel breve puo fallire clamorosamente.


Qualcuno potrebbe dire: usiamo l’AT nel breve e l’AF nel lungo periodo. Infatti tanti usano questo approccio nella convinzione che l’AT permetta di indovinare la direzione del mercato nel breve periodo. Se usate questo approccio e ci guadagnate, bravi, continuate cosi’.


L’AT è il sistema di analisi dei mercati che va per la maggiore. I giornali specializzati sono pieni di analisi condotte con tale metodologia. Per quel che mi riguarda, a costo di apparire impopolare, essa presenta degli incovenienti notevoli:


1) Non ha un reale fondamento scientifico: ovvero è da dimostrare che funzioni costantemente nel tempo a prescindere da chi la usa, percio':


2) La sua utilita' dipende molto dall’abilita’ personale del trader.

Il problema dell’AT, quindi, è che essa è costituita da una serie tecniche e metodi che hanno molto di "artistico" e poco di obbiettivo. Cioè per fare i soldi con l’AT è necessario metterci una grande dose di abilità personale che nessuno vi puo’ insegnare. I libri di AT vi insegnano delle cose che da sole non bastano. Infatti non è che voi domani cominciate a studiare l’AT venti ore al giorno e poi dopo due anni iniziate a speculare diventando miliardari.

Anche se le affermazioni precedenti riguardo l'AT non fossero vere rimane il PROBLEMA DEI PROBLEMI. Nel momento stesso in cui un qualsiasi metodo di previsione dei mercati fosse scoperto e diventasse di dominio pubblico cesserebbe automaticamente di funzionare.
Infatti i futures sono un gioco a somma zero. Ovvero, per ognuno che guadagna ci deve essere uno che perde (quando comprate un future vi deve essere uno che ve lo vende e viceversa). Non possono guadagnare tutti.
Ecco quindi che se io scopro che tutte le volte che piove sul Monte Bianco il future sul grano aumenta di prezzo, divento miliardario. Se pero’ scrivo un libro per condividere col mondo la mia scoperta ecco che la scoperta stessa perde ogni validità. Infatti da quel momento in poi non troverò più nessuno disposto a vendermi il grano quando piove sul Bianco giacché anche gli altri vorrebbero comprare col risultato che il mercato si bloccherebbe.


Insomma perché il mercato funzioni é necessaria una dose di incertezza. E’ necessario quindi che i partecipanti al mercato, usando metodi di analisi diversi, abbiano percezioni diverse di dove andrà il mercato.
La conclusione è che più speculatori usano l’AT e meno risultati essa darà.
Questo vale ovviamente per qualsiasi sistema. Anche per quello esposto in questo sito. Pero' esso non ha mai raggiunto la popolarità dell’AT, per cui state tranquilli se lo userete: siete felicemente in minoranza e lo rimarrete a lungo. Tutto a vantaggio delle vostre tasche.

A questo punto abbiamo perduto tutti i lettori che usando gli approcci precedenti (AT da sola o con l’AF) guadagnano giorno dopo giorno con regolarita’.


Chi rimane? Coloro che non guadagnano usando i summenzionati approcci, coloro che non hanno mai speculato e leggono perche' sono curiosi di vedere come va a finire, e coloro che non credono che si possa indovinare la direzione del mercato piu’ del 50% delle volte usando qualsivoglia sistema.


Il Trading Scalare e’ una validissima alternativa per queste persone. Ma non si adatta a tutti indiscriminatamente.



COSA SAPPIAMO E COSA NON SAPPIAMO SUL MERCATO. I VANTAGGI DEL TRADING SCALARE.

Diciamo addio all’AT e domandiamoci cosa possiamo dire di sapere o non sapere sul futuro del mercato, noi poveracci privi di capacita’ divinatorie.

Non sappiamo:


-quando il prezzo di una commodity salira’

-quando il prezzo scendera’

-quando il prezzo oscillera’ (ossia non va da nessuna parte)



Sappiamo, pero’ con certezza che:

a) il prezzo di una MP non sara’ mai zero (per la legge della domanda e dell'offerta)

b) prima o poi il prezzo si muovera’ lungo un trend (a salire o a scendere)


c) prima o poi il prezzo oscillera’


Per accertarvi di cio’ che dico prendete un qualsiasi grafico di una MP e vedrete alternarsi casualmente periodi di trend ascendenti, trend discendenti e periodi oscillatori. Non vedrete mai una MP valere zero.
Naturalmente vediamo solo a posteriori quando queste cose sono accadute , senno’ sarebbe troppo facile!
Ecco quindi che sappiamo tutto cio’ che ci serve per costruire un sistema di trading profittevole e sicuro: il Trading Scalare. Infatti quest’ultimo si basa su concetti (mai prezzo zero, periodi di trending alternati a periodi di oscillazione) che non sono opinabili ma costituiscono la natura dei mercati delle commodities.




IL TRADING SCALARE (TS)

Fare del TS significa acquistare una MP ad intervalli prefissati via via che il prezzo della MP scende sotto una certa soglia, rivendendo ciascuno di questi contratti ad un prezzo superiore a quello di acquisto (nelle fasi di oscillazione e nei trend ascendenti).
Vediamo con un esempio. Decidiamo di fare del TS sul rame quando questo scende sotto gli 80 cent/pound. Decidiamo che il nostro capitale ci permette di acquistare un contratto ogni 2 centesimi per un totale di 6 contratti. Se il prezzo del rame da 80 scende a 70 noi avremo acquistato 6 contratti ai seguenti prezzi:

Acquisto a 80, a 78, a 76, a 74, a 72, a 70.

Cioe’ noi acquistiamo lungo una "scala" composta da 6 gradini. Ogni gradino (livello) dista (in questo caso) 2 centesimi dal gradino successivo. Ammettiamo ora che il prezzo del rame, dopo essere sceso a 70, cominci a risalire fino a 82 cent/pound. Noi allora rivendiamo ciascun contratto 2 centesimi (in questo caso) sopra il prezzo di acquisto: il contratto acquistato a 70 lo rivendiamo a 72, il contratto acquistato a 72 lo rivendiamo a 74 e cosi’ via fino a che non vendiamo l’ultimo contratto, acquistato ad 80, a 82.

Compro a 80 e vendo a 82
Compro a 78 e vendo a 80
Compro a 76 e vendo a 78
Compro a 74 e vendo a 76
Compro a 72 e vendo a 74
Compro a 70 e vendo a 72

Quindi noi acquistiamo man mano che il prezzo scende e rivendiamo man mano che il prezzo sale ad un prezzo piu’ alto di quello d’acquisto.
Se la MP oscilla all'interno di questo range a noi va benissimo perche' compriamo e vendiamo in continuazione. Se ad esempio il prezzo va da 74 a 76 noi vendiamo il contratto acquistato a 74. Se poi il prezzo torna a 74 noi ricompriamo per poi rivenderlo quando torna a 76. Se questo va e vieni si verifica diverse volte noi abbiamo accumulato un bel gruzzolo anche se il prezzo non e' andato da nessuna parte.

Noi compriamo quando il prezzo scende perche’ sappiamo che questa discesa, per la legge della domanda e dell'offerta (LDO), non puo’ andare oltre certi limiti. Quali sono questi limiti? Come tesi generale possiamo dire che essi sono rappresentati dal prezzo di produzione della MP.

Cio’ NON vuol dire che il prezzo di una MP non possa andare sotto il prezzo di produzione per un certo periodo di tempo (anche parecchi mesi). Vuol dire che quando questo si verifica la LDO comincia a lavorare dalla nostra parte favorendo la risalita del prezzo.


Uno splendido esempio, al fine di focalizzare il concetto, e’ quello della palla in acqua. La palla e’ la MP e la superficie dell’acqua e’ il prezzo di produzione. La palla (materia prima) galleggia naturalmente "sopra" l’acqua. Noi possiamo, a forza, spingerla sott’acqua. Ma la palla opporra’ resistenza e tendera’, con altrettanta forza a tornare non solo in superficie ma addirittura a schizzare verso l’alto. Cosi’ e’ per le MP. Quando i prezzi sono depressi ed i produttori vanno in rosso, la LDO crea le condizioni perche’ il prezzo risalga, spesso con una velocita’ ed una "forza" impressionanti.
Un’altra metafora che aiuta a capire il concetto e’ quella della molla, la quale puo’ essere si’ compressa, ma tendera’ inesorabilmente a ritornare al punto di equilibrio.
L’andamento ciclico delle MP permette allo TS di funzionare: quando i prezzi scendono a livelli storicamente bassi noi acquistiamo, quando i prezzi risalgono noi vendiamo. Quando il prezzo oscilla noi siamo felicissimi perche’ compriamo e vendiamo in continuazione.
Il contrario esatto di quello che fanno "gli amici del trend" (trend followers) i quali vendono quando il prezzo scende e comprano quando il prezzo sale. Il fatto che la maggior parte degli operatori sul mercato siano trend followers (compresi i fondi comuni) rende lo TS ancora piu’ interessante. Infatti il mercato future e’ un gioco a somma zero: cioe’ per ognuno che guadagna una lira c’e’ sempre uno che la perde. Quindi se quando c’e’ un trend a salire tutti vogliono seguire il trend, mi spiegate dove trovano qualcuno che si pone come controparte e che quindi e’ disposto a vendere cio’ che loro comprano? Questo e’ uno dei motivi per i quali i piu’ diffusi approcci al mercato spesso non funzionano: perche’ sono in troppi ad usarli.
Lo stesso varrebbe per lo ST se tutti lo usassero come metodo di trading: non funzionerebbe piu’. Per intanto godiamoci la folla di "amici del trend" che e’ felice di venderci una MP quando il prezzo scende ed e’ altrettanto felice di acquistarla quando il prezzo sale.
Quindi lo TS ci permette di fare trading anche se le cose che sappiamo sul futuro andamento del prezzo sono limitate ai tre punti ricordati sopra.




Il TRADING DI POSIZIONE (TP)

Il TP e' il padre del TS. Consiste nell'acquistare un contratto di una commodity quando il prezzo e' molto basso e rivenderlo quando il prezzo e' salito senza preoccuparsi dove va nel frattempo. Punto e basta. E' utile per chi ha capitali limitati e non puo' permettersi di comprare diversi contratti via via che il prezzo scende. Con il TP il problema e' risolto. Compro, aspetto (dovunque vada il prezzo) e rivendo (quando ho ottenuto il guadagno previsto). Non e' eccitante, non e' rischioso, MA FUNZIONA. Infatti se noi acquistiamo quando il prezzo e' veramente basso e' praticamente impossibile che esso scenda E SI MANTENGA ancora piu' basso per piu' di qualche mese (potenza della LDO). E' banale ma funziona.

 

[Fleursdumal]

Commentaries by Bruce Babcock for both New and
Experienced Traders




The Best Way to Trade with Limited Capital

One of the biggest swindles unscrupulous commodity vendors are pulling is to suggest that you can be a successful commodity trader with minimum capital. In order to sell their trading courses, they claim you can make a fortune starting with whatever amount you currently have available.

Most thoughtful experts agree that there is a minimum below which success is determined by luck. I set that amount at $10,000. Below that, it is nearly impossible to apply proper risk management principles. Studies have shown that success is directly proportional to the amount of capital you have. To maximize your chances of success, it is best to have at least $75,000.

My best mechanical system for small traders requires at minimum $15,000 for a conservative approach involving a five-market portfolio. Without a little luck, trading that system with limited capital may require extraordinary patience to wait for the system's statistical advantage to assert itself.

If I had to trade with less than $15,000, how would I do it in a way that would maximize my statistical advantage? My suggestion is to pick a few classical chart patterns and specialize in trading with them. You must have discipline and patience to wait for the patterns to develop correctly using only markets suitable for small accounts. Additionally, you must apply strict risk management and have great tenacity to let your profits run on the good trades.

Mid-America Exchange mini-contracts are a viable alternative for small accounts and highly recommended. Full-size contracts would occasionally be all right in such markets as Gold, Cotton, Soybean Meal, Soybean Oil and Oats.

The best book on chart pattern trading in futures is Peter Brandt's Trading Commodity Futures with Classical Chart Patterns [available from Reality Based Trading Company]. Peter has been earning his living trading this way for over 25 years. His entry approach is to identify clearly defined chart patterns as described in the Edwards and Magee classic, Technical Analysis of Stock Trends, with a "measured move" representing a profit potential of at least $2,000 per contract and a reward/risk ratio of at least 3 to 1.

There are some further requirements described in his book. For those who want to follow and learn from Peter's trading, he publishes a newsletter called The Factor (719-471-6898).

Another successful expert who uses chart patterns for entry is Steve Briese, publisher of the Bullish Review (612-423-4900). This excellent newsletter reports on and analyzes the CFTC Commitments of Traders reports. Steve's personal trading approach is to concentrate on only two kinds of patterns. Here's how he described his method in an extensive, exclusive interview available from Reality Based Trading Company.

II continue to believe that using standard chart patterns is a very lucrative way to trade. I've gone back to look at what has worked and tried to reduce the chart patterns down to a manageable few. The first is a failure swing top or bottom, which may be a double top or bottom or the last part of a head and shoulders or triple top or bottom. These are reversal-type patterns.

The other one is a coil. That would include any type of triangle which is a consolidation. It is typically a continuation pattern, but it can also be a reversal pattern.

The problem with these patterns is that to trade a breakout and put your stop on the other side of the pattern usually creates more risk than I want to take and that most traders should take based on their account size. The typical approach to this would be to trade the breakout when it comes, but to put your stop at a money risk distance from the entry.

I take the opposite approach. First, I determine where my stop-loss should be based on the pattern. I want to put my stop at the point where the pattern fails. Then I determine how much I'm willing to risk on the trade. In my case I never risk more then $500 per contract on any trade. I don't trade the S&P, where that would be difficult.

After I've established my stop, I know what the exit point will be. Now I have to find the entry point that will keep my risk within the required amount. This will usually be at a point before a breakout verifies the pattern, still within the pattern. I use the Commitments of Traders data to forecast which way a pattern is going to complete.


I continue to believe that using standard chart patterns is a very lucrative way to trade. I've gone back to look at what has worked and tried to reduce the chart patterns down to a manageable few. The first is a failure swing top or bottom, which may be a double top or bottom or the last part of a head and shoulders or triple top or bottom. These are reversal-type patterns.

The other one is a coil. That would include any type of triangle which is a consolidation. It is typically a continuation pattern, but it can also be a reversal pattern.

The problem with these patterns is that to trade a breakout and put your stop on the other side of the pattern usually creates more risk than I want to take and that most traders should take based on their account size. The typical approach to this would be to trade the breakout when it comes, but to put your stop at a money risk distance from the entry.

I take the opposite approach. First, I determine where my stop-loss should be based on the pattern. I want to put my stop at the point where the pattern fails. Then I determine how much I'm willing to risk on the trade. In my case I never risk more then $500 per contract on any trade. I don't trade the S&P, where that would be difficult.

After I've established my stop, I know what the exit point will be. Now I have to find the entry point that will keep my risk within the required amount. This will usually be at a point before a breakout verifies the pattern, still within the pattern. I use the Commitments of Traders data to forecast which way a pattern is going to complete.


The biggest problem in trading with a small account is finding reasonable stop-loss points and still keeping risk to an appropriate level in relation to your account size. Since strings of losses are inevitable regardless of your approach, you must control risk so you are not wiped out by consecutive losers. Experts agree that for proper risk management, you should limit risk to no more than about one percent of your account equity. This is impossible with a small account.

Steve Briese has been successful with stops under $500. Peter Brandt's average loss is generally under $400. You must be patient to wait for entries that qualify under your rules where you can place an intelligent stop at a point which will limit risk to less than $400-500. If the current volatility is too large to accomplish this, you must pass the trade.

While novice traders spend all their time working on entries, seasoned traders know that the really difficult decisions in trading involve exiting profitable positions. Letting profits run on good trades is absolutely essential to long-term success.

I believe that judicious trailing stops are the best way to let profits run. On multiple contract positions Steve Briese uses a combination of trailing stops and volatility. Peter Brandt prefers exiting at pattern objectives.

While successfully trading commodities with limited capital presents the highest challenge in trading, you can do it if you recognize the problems and construct a trading plan to accommodate the realities.

 

[Fleursdumal]

ODJ CSCE Coffee Review: Up But Pares Rise After Funds Sell
-- Market Building A Base Where It Did Two Months Ago
-- Brazilian New-Crop Forecast Should Be Out Thursday
-- Plenty Of Rain In Minas Gerais, Brazil, This Week

By Susan Buchanan
New York, Dec. 17 (OsterDowJones) - Arabica coffee futures advanced on the
Coffee, Sugar & Cocoa Exchange Tuesday, but fund selling trimmed an early rise
that took Mar to a 4-day high.
Mar settled 90 points higher at 62.15c a pound and May ended up 95 points
at 64.50c.
"Roasters, speculators and locals were early buyers following London," a
floor broker said. "But someone, probably a fund, kept Mar from getting to
63.00c.
"There are buy stops at 63.00c," he continued. "Funds did a little
selling, and we gave back some of our gains.
"I was impressed with London's up day," however, he added.
CSCE Mar gapped up and surged 155 points to a 4-day high of 62.80c in
early action. The market ran into selling and eased, but stayed in positive
ground.
Futures volume was estimated at 7,178 lots. In the options ring, 3,131
calls and 2,637 puts traded. Over 800 against actuals were posted, mostly in
Mar with a few in May, Jul and Sep.
"The trade's been buying the Mar/May spreads recently, and there's been
good buying in the Mar 70-80 call spreads," the broker said. "People are
saying funds got out of longs recently in a sloppy, badly managed way.
"They panicked and all liquidated at once," he continued. "Some funds are
getting short and they may have to cover if the market moves against them
after Brazil's crop report."
The market appears to be building a base now in the same area where it
made a base two months ago and advanced, the broker observed.
Most of Minas Gerais, Brazil's top growing region, remains very damp. Rain
Monday was generally less than 27 mm, with higher totals in far northwestern
Minas Gerais. Isolated showers occurred across parts of Parana and Sao Paulo.
Scattered showers are expected across central Brazil through Friday, according
to Global Weather Services.
"Rain that Minas is getting now is late, since they already went through
flowering," from October into November, the floor broker observed.
Current moisture helps to maintain trees after earlier dryness, however.
Brazil is in the start of its summer.
Brazil's 2003-04 crop should be at least one-third smaller than the last
harvest of 51.6 million bags in a forecast from the Ministry of Agriculture
this week. Officials will probably release the estimate Thursday.
U.S. stocks rose 31,650 bags as of Nov. 30 to 5.545 million bags from
October, the Green Coffee Association reported Monday.
The CSCE Dec contract expired Tuesday, and Wednesday is last notice day.
Chart support for CSCE Mar lies at 61.60c to 61.50c, 60.50c, 60.00c,
59.50c, 59.00c and 58.40c, traders said.
The CSCE will be open on Dec. 24 and closed Dec. 25 and 26.

Settlement prices in cents/pound, dollars/metric ton
CSCE Change Range Liffe Change
Mar 62.15 up 0.90 61.60-62.80 Jan 751 up 29
May 64.50 up 0.95 64.00-65.10 Mar 770 up 30

 

[Fleursdumal]

Paul McKnight's Scale Trading "Attempting to Reduce Risk" Page



Attempting to Reduce the Risk of Trading Commodity Futures

by Paul McKnight, President
Buffalo Trading Group, Inc.
Mailing address: 6255 East Duke Ranch Road
Pearce, AZ 85625-6113
(520) 824-4051 or (800) 318-1952
Fax: (209) 885-8449



THE PROMISE AND POTENTIAL OF TRADING COMMODITIES

Everybody dreams of getting rich. Very few people ever get rich enough to be financially independent. Financial independence means being able to decide for yourself what you will do each day, how you will spend your time, and where you will go. Financial independence means freedom from the usual restrictions that are placed on our lives by the need to work in order to survive. Ultimately, financial independence means freedom from work. This report will show you some possibilities for getting rich and achieving that freedom by buying and selling commodity futures and options. It will also show you ways of handling the risk of loss that is always present whenever there is a potential for gain.

The Risk of Trading Commodities
My definition of risk consists of four words: The possibility of loss. Buying and selling commodity futures is a highly leveraged activity. This means that if things go well, it is possible to take a small amount of money and quickly turn it into a big pile of money. (You may have heard that Hillary Clinton turned $1000 into $100,000 trading Live Cattle futures. Don't try this at home!) It also means that if things don't go well, it is possible to take a big pile of money and lose it all in the blink of an eye. Any highly leveraged activity is inherently risky.

This report will explain ways I have found to attempt reduce the level of risk in trading commodities. This low-risk approach is not a "get rich quick" strategy. It is only valid if you don't run out of money while executing the strategy.

FORGET ALL THAT TECHNICAL STUFF

Most literature about trading commodities goes into lots of highly technical theories about moving averages, oscillators, trendlines, crossovers, reversals, support, resistance, chart formations, channels, etc. There is only one problem with cluttering your mind with all this junk: it doesn't lead you to successful trading. There is absolutely no link between how much technical knowledge a person has and how successful that person is with actual buying and selling. I said NO LINK! Zero! None! You could be the most knowledgeable person in the world about the technical aspects of price movements and still be completely and miserably unsuccessful as a commodity trader. This report will point you toward trading success without teaching you any more than a couple of very basic facts about price movements. All you really have to do is buy low, sell high, and avoid losses.

You can spend a lot of money on tools, chart services, computers, computer programs, secret trading systems, newsletters, and other junk, but, again, there is NO LINK between acquisition of any expensive tools and trading success. I hope to show you that you can trade successfully using nothing more than a newspaper. I'm sure that all the vendors of those expensive devices and services would rather have you spend your money on them, but it is not necessary or even helpful for you to do so. You can save hundreds or even thousands of dollars by avoiding all of them. They are not necessary.

RISK REDUCTION STEP 1: CHOOSE THE RIGHT RISK MANAGEMENT STRATEGY

Commodity traders generally use one of three known strategies for managing risk. The first is the "Stop loss" strategy. The second is the "insurance" strategy. The third and least used is the scale or interval-based position trading strategy. After four years of trading in the commodity markets, I settled on the interval-based position trading approach. In the paragraphs below I examine these three methods with their advantages and disadvantages.

The "Stop loss" strategy - not recommended
Using the "stop loss" strategy, a trader will decide how much money to risk when buying or selling a futures contract. After initiating a trade, an order is placed to undo the trade at a point where the pre-decided amount of money would be lost in the event of an adverse market movement. The local traders on the exchange floors love this one because they make their living through a process known as "running the stops". The stop loss orders entered by off-the-floor traders become convenient targets for the locals as they run the price up and down just far enough to trigger the stops.

When a "stop loss" order is triggered, it becomes a market order, meaning that it will be filled at the next available price. This is usually at least one price tick worse than the price level which triggered the order. This is known as "slippage". It is not uncommon for the fill price to be four price ticks worse than the specified price. The fill price is almost never better than the trigger price.

Thus, the "stop loss" trader plans for losses and usually gets them. When they arrive, they are usually larger than planned. When an opening gap in prices occurs, the loss can be much larger than planned. If a market opens lock limit down several days in a row, as has been known to occur in the commodity futures markets, the "stop loss" loss can be truly gigantic.

Here is the government-approved warning about "stop loss" orders:

THE PLACEMENT OF CONTINGENT ORDERS BY YOU, SUCH AS "STOP-LOSS" OR "STOP-LIMIT" ORDERS, WILL NOT NECESSARILY LIMIT YOUR LOSSES TO THE INTENDED AMOUNTS, SINCE MARKET CONDITIONS MAY MAKE IT IMPOSSIBLE TO EXECUTE SUCH ORDERS.

The "insurance" strategy - occasionally recommended for consideration
Using the "insurance" strategy, a trader will take a position in a market using a futures contract or by selling an option. An "insurance policy" in the form of an option which will limit losses on the original transaction is then purchased. Just like in real life, insurance costs money. However, it provides much more flexibility than a "stop loss" order.

Here is an example of how an insurance policy would work. Suppose a market has had a big selloff and a trader thinks it is ready to turn around and go up, The trader buys a futures contract or sells a deep-in-the-money put. To manage the risk that prices will continue going down rather than reverse and go up, the trader would purchase an at-the-money put option, which gives a clearly defined protection level by setting a maximum possible loss for the trade. Prices can then proceed to go down without inflicting further damage on the trader or triggering a "stop loss" order that would remove the trader from the market, possibly right before the price actually does turn around and soar.

I recommend that the insurance strategy be considered for small accounts and for markets not suitable for the third strategy: interval-based position trading.

The interval-based position trading strategy - recommended for consideration when capital is sufficient
Interval-based position trading is a disciplined, mechanical approach to buying low and selling high. A buying scale is established based on available capital such that a commodity is bought at pre-determined price intervals that are approaching a natural barrier such as the cost of production or a multi-year support level, The buying scale is set so that even at the lowest projected price, capital is still available in case the price goes even lower. Each futures contract acquired is later sold according to a pre-determined selling scale that provides a fixed profit for each contract. If the contracts expire before that pre-determined selling price is reached, the position is rolled over into a subsequent contract month and the selling scale is adjusted to compensate for the rollover costs. Please note that such rollovers involve taking a loss on current contracts which you intend to re-capture as you sell the distant contracts at your desired price.

Thus the three elements of this "Buy Low Sell High" strategy are the buying scale, the selling scale, and the capital required to hold whatever inventory is acquired until it can be sold at the desired price. It should be noted that the interval-based position trader never tries to hit a home run, but aims for hitting a single each time at bat.

The potential weak spot in the interval-based position trading strategy is the possibility of running out of capital before the price turns around. Acquiring contracts on a buying scale causes paper drawdowns that increase dramatically as the price decreases. $30,000 in initial capital is recommended for interval-based position trading, but it can be done for less in some markets. There are several 1/5-size contracts on the Mid-America Commodity Exchange. Without proper capitalization, market selection, and entry point selection, interval-based position trading can be just another method of committing financial suicide.

These and other topics are covered in subsequent risk reduction steps, which assume that the interval-based position trading strategy is being used.

RISK REDUCTION STEP 2: CHOOSE THE RIGHT MARKET

The interval-based position trader is very careful in selecting a market in which to begin a scale. Several markets are excluded by their very nature because they do not have built-in natural price barriers that provide a potential bottom end. Currencies are not suitable for this sort of trading because there is no natural barrier preventing governments from debasing their currencies to the point of no return. Individual stocks are not suitable for interval-based position trading because there is no natural law against bankruptcy, which causes the stock price to go to zero and remain there.

Most commodities have the law of supply and demand to eventually halt and reverse price declines. As the price gets lower, producers stop producing the commodity. This limits the supply of the commodity and causes accumulated supplies to be used up. As supplies get tighter, the price rises to provide an incentive for the producers to resume production. Without the law of supply and demand, interval-based position trading would not be possible. The author is a follower of the Austrian School of Economics, which postulates that most economic decisions are based on price. Consumers decrease their buying when prices rise and producers decrease production when prices fall. In both cases, the signal providing the cue for the decision is the price.

Thus, the basic framework for choosing a market has been established: Avoid markets for paper assets. Trade the real commodities and trade only from the long side. Any market whose price is in the lower third of its ten-year range should be examined to see if it is suitable for interval-based position trading. Look for a market in which supply and demand are pretty well balanced or improving after a period in which they were unfavorable. Look for a market in which the price is close to previous low turnaround points or below the average cost of production.

RISK REDUCTION STEP 3: SET UP A CONSERVATIVE BUYING SCALE

The key to establishing a buying scale is to ensure that you still have a reserve supply of capital at the lowest forseeable price. This allows you to avoid losses caused by running out of capital. If you have unlimited capital, a buying interval equal to about one third of the average weekly price range would provide near-optimal spacing.

It is an unfortunate characteristic of commodity futures trading that when you run out of money, you can lose all of the money you originally invested and more. The margin enforcer, wearing his black hood, does not care that you are an interval-based position trader. That will not save you from his ax if you get a margin call and are unable to speedily add funds to your account. He'll sell you out of your big inventory just as quickly as he'll sell out a more adventurous trader who initially buys more contracts that he can afford to support and gets a big margin call the next day. You can't bluff the market by pretending you have more money than you really have. The market will eventually call your bluff.

Prices in futures markets can go lower than anyone expects, so it pays to be conservative here. Ideally, one would establish a buying scale that would leave reserve capital even if the price fell to near zero.

Since interval-based position traders are in the business of accumulating inventory to be sold later at a higher price, it is natural for their accounts to be carrying paper losses for some or all of the contracts in inventory. This condition is called drawdown, and it is generally greater for interval-based position trading accounts than for other types of accounts.

RISK REDUCTION STEP 4: SET UP A SELLING SCALE

If you are accumulating contracts on a scale down, what do you do with them? The answer is that you sell each contract at some pre-determined level above its purchase price. The selling scale is usually at least as wide as the buying scale, and sometimes wider.

Of course, setting up a selling scale does not guarantee that the market will carry the futures contract price up to your selling level, but it allows you to aim for hitting singles rather than trying to hit home runs.

The goal of interval-based position traders is to establish buying and selling scales that will let the natural fluctuations of the market force them to buy low and sell high. When this happens properly, it is just like having a money pump that pumps money into your commodity account. Of course, if the price were to plummet and never recover after you begin accumulating, the inactive pump would siphon money out of your account.

What usually happens in markets is that they fluctuate from level to level in such a way as to cause you to buy and sell contracts at intermediate levels several times. So while you may eventually get down several levels deep in your scale and then eventually get back out of the scale, chances are that during that time you would buy and sell many contracts while the market fluctuates in its travels. Your total profits after successfully completing all your sales at the target prices will be a function of the total number of contracts you bought and sold while you were in the scale.

RISK REDUCTION STEP 5: ROLL OVER YOUR INVENTORY AT CONTRACT EXPIRATION

As you know, futures contracts are of limited duration and they eventually expire. If they expire while you are still in a scale, don't just give up and take a loss. Sell each contract you have on hand when expiration day approaches, and buy contracts for a later expiration month to replace them. When you do this, you will incur additional transaction costs and you will probably have to pay higher prices for the later contracts due to what are known as carrying costs. This means that you will want to add the extra costs to your target sale prices, raising the sale price for each contract enough to recover those costs.

This rollover process temporarily converts any paper losses on the expiring contracts to realized losses. The realized losses are recovered when the price of the new contract reaches the selling point. Most discussions of futures and options trading seem to assume that the trade ends when expiration day or first notice day arrives. In my opinion the trade ends when the profit on a futures contract or option OR ITS ROLLED-OVER SUCCESSOR is booked.

Another potential weak spot of the interval-based position trading approach is the theoretical possibility that prices go down and stay down forever, never reaching ther target sale price for the highest contracts. Each rollover would raise the target sale price by the amount of the rollover expenses.

RISK REDUCTION STEP 6: USING SHORT PUTS AS AN ALTERNATIVE TO FUTURES

Substituting the sale of put options for the purchase of futures contracts adds flexibility to the process of interval-based position trading while reducing the chance for profits on interim price fluctuations.

Rather than buying a corn futures contract at 225, an interval-based position trader might wish to sell a put option with a strike price of 220. The money received for the option sale goes directly into the trader's account at the time of the sale (less transaction costs). If the price of Corn is above 220 when the option expires, the trader gets to keep all that money. If the price of Corn is below 220 at option expiration, the trader buys back the option and sells an option for a later month. If the price of Corn drops far enough to allow the trader to sell a second option with the next lower strike price (210) for the same amount of money, this is done. So put options are sold on a scale down much like futures contracts are bought on a scale down.

The advantage is that, like lawyers, option sellers get their money up front. Another advantage is that when rolling over an option, the extra time value present in the option of the later month may cover the transaction costs of the rollover. There is also some additional flexibilty in options at rollover time. For example, if you had to buy back 3 Cocoa options for 12, 62, and 102, or a total of 176, you might be able to sell 4 options at a lower strike price for a later month to bring in enough to cover the 176 plus rollover costs. The lower strike price means when the price of Cocoa eventually rises to make the options worthless, they will become worthless sooner than would options with a higher strike price.

Note that the risk of loss is only slightly lower if you sell a put than if you buy a futures contract. In either case if the future were to go to zero, you would be in big trouble. You would be in a tiny bit less trouble with a short put because you took in some premium up front.

The disadvantage of using options instead of futures is that futures prices fluctuate faster than option prices. The interim trades picked up while a futures trader is in a scale and prices are fluctuating enough to allow futures contracts to be bought and sold several times at the same price level are not picked up by the options trader, because option values only go to zero at expiration time.

Many times it is advantageous to begin a scale buying futures contracts and then switch to selling put options if the rollover time arrives while still in the scale. Many traders will skip buying the futures contract and go directly to selling a put. I personally like selling options so much that I sometimes have referred to myself as a premium farmer, harvesting option premiums. The term "premium" describes the price of an option.

Covered calls as additional risk reduction for long futures contracts
While on the subject of options, I will mention here one additional enhancement I have developed for interval-based position trading using futures contracts. If you get into a scale that bogs down and looks like it will go several layers deep, I recommend you consider selling call options on the contracts you are holding. The calls would be far enough out of the money that if the holder were to call the futures contract away from you, it would be at or above your intended selling price anyway. The premium received from selling the calls helps one endure any drawdowns on the futures contracts. Another example of premium farming.

 

[Fleursdumal]

Principles of Scale Trading



Scale trading is a disciplined, mechanical approach to medium to long-term investment in commodity futures. It is a methodology based on the assumption that commodity prices ultimately move on factors affecting supply and demand. Two basic principles guide the scale investment strategy.

Is it a bargain price?
Are the supply and demand dynamics about to change in a significant and favorable way?
If the answer is yes to both questions, the investor begins buying the commodity at progressively lower prices until it stops declining. Once contracts are bought, they are then sold at progressively higher prices.



The Benefits of Scale Trading


Rather than using heavy leverage to chase large market movements, scale trading provides the ability to de-leverage commodity futures are a high risk arena. Scale trading provides a conservative trading plan for implementing within this high risk arena.

With scale trading, more of the equity in the account is committed to each trade and the volume of trading is much less -- producing an additional benefit of less commission expense than with most futures accounts. The trading strategy involves taking consistent small profit, rather than riding big, flashy run-ups (followed by equally flashy run-downs).

The results, both in terms of returns and risk profile, are completely different than the type of futures trading which causes most investors to leave futures out of their portfolios.

Tremendous opportunities can exist using the scale trading methodology.



The Law of Supply and Demand


The law of supply and demand says that as the price of a commodity such as wheat falls then the demand for wheat increases. As the wheat price approaches or even falls below its cost of production, producers will be inclined to cut back or switch to a more profitable crop, thereby reducing the available supply for the coming year. As supply shrinks, buyers competing for less and less wheat eventually push prices higher in order to ration demand. This higher price in turn motivates producers to increase production, thereby increasing supply. This results in lower prices. . .and the process starts all over again.

Because of the economic cycle of supply and demand, "Mother Nature" commodities, particularly those grown for human consumption, are used for scale trading. Supply and demand create practical low ranges for commodity prices. "Mother Nature" commodities have intrinsic value, and therefore are not likely to become valueless. Because of costs of production, the investor knows that wheat prices will not fall to $ 0 and more likely will have a much higher support price -- which puts some practical limits to his risk.

The concept of intrinsic value does not necessarily apply to other investments. For instance, the stock of today's hot company could actually go to zero due to any number of micro or macro-economic circumstances.

A scale investor enters the cycle when he feels prices are about to rise from their lows. Along with such factors as decreased acreage in the United States, the investor also looks for global fundamentals that prices could rise well above contract purchase prices as the supply/demand cycle continues.

The beauty of the scale trading approach is that the investor can outline the trading plan ahead of time by carefully evaluating current supply/demand statistics and then comparing them with the commodity's historical price range. This gives the ability to pinpoint the price at which to begin scale-down buying and, most importantly, calculate the total capital needed to maintain that scale under the worst case scenario.



The Scale Method: Selecting and Managing a Scale


A scale investment plan is created when a commodity's price is cheap and the investor is convinced things are about to change. This plan will determine capital requirements as well as the number of contracts and at what prices to buy and sell. To develop a plan:

Choose a market that is trading in the lower 30% of its historical price range. Commodities that are produced and consumed are preferred for scale trading. Paper assets such as currencies and stock indexes are generally avoided.
Evaluate the seasonality of the commodity in question. Timing when to start a scale can make a big difference in the performance of your scale account.
Review fundamental factors. What are the short and long-term supply/demand expectations for the commodity? This means, with soybeans, for example, planting intentions, acreage planted, crop conditions, previous year's crop carryover, exports, etc. This additional information not only helps in determining the probable areas of price support -- i.e. will the commodity's price hold at or above its historic lows? -- but more importantly helps determine when significant changes are imminent.
If the above criteria is supportive, then a scale investment plan, based upon available capital, is constructed. The plan begins with purchases near the probable low and makes additional purchases at specified price intervals down to the lowest projected price. There should be at least 30% of capital left in reserve, after allowing for any losses on open positions as well as margin requirements (margin requirements are deposits required by the exchange and the amount required can change without notice).
Enter limit order GTC (Good till Canceled) to purchase the commodity (going long, never short) on an incremental scale all the way down to a level determined to be a "worst case" scenario. Keep in mind that stop-loss orders are not used since the purpose is to accumulate contracts at lower prices.
As each buy order fills, enter a limit sell order to close out the position at a pre- determined price that normally captures a $250-400 profit (net of fees and commissions). This profit objective will vary depending on the investor's personality and market conditions.
As each sell order is filled, then reinstate the original buy order. As prices fall, contracts are accumulated. As prices rise, those contracts are sold at a profit.
Continue this process until the commodity bottoms and rallies up to the point at which your first contract purchased is sold. You have now completed your first scale.


How to Calculate the Amount of Capital Required


Two factors determine the capital required for a scale. How wide or narrow the buying increments are, and the margin requirement for each contract purchased. We use a computerized worksheet, but the calculations can be done by hand. Maintenance margin is used for the calculations.

Keep in mind that margin requirements can change without notice.



Why Can't You Scale Trade from the Short Side?


All markets have a downside limit of zero and a likely downside around their cost of production. However, what is the upside limit to a market? The fact is that it is very difficult to determine the upside limit. Under the right circumstances, prices can greatly exceed previous highs. What would have happened if you had been short scaling soybeans in 1973? Prior to the end of 1972, the highest all time price for beans was $3.75 per bushel. In 1973, the price went to $12.90 per bushel. While the price has never returned to those levels, you have to account for the possibility that prices could eventually exceed those levels. Only when scale trading from the long side can the approximate risk be determined and managed appropriately.



What is the Life of a Scale?
What if My Contract Goes Off the Board?


If by first notice day you are still holding contracts in your scale, you must execute a "rollover". In a rollover you close out your positions in one contract month and reestablish the trade in a later month. When a rollover is completed you will realize the paper losses you have been carrying in the scale and enter into the new contracts at the then current price. Your sell orders for these new contracts are established in the new contract month. Please keep in mind that when you sell your old contract and buy a new contract that this is a transaction that will incur commissions and fees. In any scale, the objective is to trade in a later month that offers the price, volatility, liquidity and time needed to close out the scale.



What Can Go Wrong?


In selecting the scale parameters we have evaluated current supply/demand fundamentals and determined that the commodity is in the lower 30% of its historical trading range. Buy/sell lines and the capital required to maintain the scale are based on that assessment. BUT, what if the fundamentals change drastically and the price falls below the worst case scenario? A seasoned scale trader will eventually have this experience to some degree or the other. This will be a hair-raising experience. However, there is no problem as long as the account maintains adequate capital reserves to back the position and the world still has a demand for the commodity. We use three possible downside targets when planning our scales:

The most likely low that analysis suggests.
The lowest conceivable price under the worst imaginable circumstances.
A price 15-30% lower than our worst case scenario.
Obviously, if you run out of money you will be forced out of the market and will lose the lion's share of your capital allocated for that scale. In an extreme situation, such as wheat linked to cancer in humans, then obviously we would most likely get out and take the loss. In the absence of such an extreme, however, the law of supply and demand should eventually work the price of the commodity back in your favor. You should have a clear understanding that scale trading is not a free lunch, there is substantial risk. The primary risk is that the law of supply/demand somehow stops working. While this routinely seems to occur in the short run, it is very unlikely to happen in the long run.



Why Can You Lose Money Scale Trading?


In our experience the primary reason investors lose money scale trading is that they let their ego get ahead of their pocketbook. They either pursue too many scales at one time or they get too aggressive in one scale. An important point to consider before you begin Scale Trading is how much "emotional capital" you have. Almost everyone enjoys Scale Trading when they are buying and selling in the top 1/3 of the scale. They are buying and selling and buying and selling and don't seem to care which way the market goes.

It is at the bottom 2/3rds of the scale that the going gets tough. It is important to assess your level of tolerance for large drawdowns in equity as well as drawdowns in your emotional capital. In our experience, people who lose using this method lose because they bail out, frequently right at the lows, having been influenced by the thinking of the experts that "this time is different" and that silver is going to $2.80/oz. or crude to $8.00/barrel. While potentially this can happen, (and you would be well advised to be prepared for that possibility), you would be much better served by instead confirming adequate cash reserves and then re-affirming your belief in the principles driving the law of supply and demand.



What To Expect From A Scale Trading Brokerage


Make sure the firm you choose has experience with Scale Trading. Like any methodology there are fine points and idiosyncrasies that need to be addressed.

The execution of your scale by your broker can require close monitoring, so it is important that other brokers in the office also understand scale trading and be able to fill in when your broker is at lunch or on vacation.

Your broker should be able to provide you with long-term fundamental information on the scales you are pursuing. Day to day fundamentals are not nearly as important.