Commodities 101: Tips and Tricks from a Former Exchange Floor Trader
Louis Basenese and the gang regularly discuss innovative investment ideas and strategies.
But there’s one investment technique that we haven’t covered much in Wall Street Daily. And that’s commodities trading.
That’s why we’re going to start covering the commodities markets and offer some advice to those of you looking to diversify your portfolio.
And that’s where I come in.
You see, I’ve been involved with commodities trading for twenty years now, both “downstairs” as an exchange floor member and “upstairs” as a trader staring at screens. So I’m going to start putting my experience to work for you, delivering a series of articles that pinpoint ways to play the commodities market, while providing some useful info and tips about the sector along the way.
So, let’s jump right in.
First, a Few Basics
Commodities refer to the actual physical products that can be traded on a qualified exchange within the United States, just like with stocks.
One of the biggest benefits of trading commodities is that there are only about a dozen markets worth looking into based on volume and liquidity. And when the number is that small, you really get to know the market’s behavior and seasonal tendencies.
This allows you to become intimately familiar with each commodity, which makes trading them much more profitable over time.
The commodities I track are broken down into four sectors:
- The Grains: corn, soybeans and wheat
- The Energies: crude oil and natural gas
- The Softs: coffee, sugar, cocoa, cotton and orange juice
- The Metals: gold and silver
Another great thing about trading commodities is that they tend to move in more predictable and smoother patterns over the long run compared to stocks. That’s because they truly react to supply and demand and government reports that give updates on a crop’s progression during the season.
There are no CEOs, company mergers or quarterly reports to get in the way. And the Fed’s not trying to intervene, either. This makes nailing down a promising commodity easier than predicting a stock’s future movement.
Sure, commodities can move erratically in the short term just like stocks. But they tend to follow a more predictable pattern in the long term.
With that said, trading commodities means that we need to keep completely different indicators on our radar. Like crop growing patterns, seasonal tendencies and weather.
The amount of rain in the Midwest could have a huge effect on corn prices… A hurricane sweeping through Florida would likely impact an upcoming orange crop… And a cold winter could end up depleting natural gas supplies.
All of these events and more will affect commodity prices. But again, it also allows us to get a better grasp on a specific commodity’s future price direction, which can ultimately lead to more profits for you.
Now that we’ve covered a few indicators I’ll be tracking, let’s get to the basics of how you can make these trades if you decide to take action.
Enough Talk. Let’s Get Started
Other than buying the actual product like orange juice or coffee at your local grocery store, you can speculate on the future movement of physical commodities by buying or selling futures and futures options contracts.
Don’t let these terms scare you off, though. Commodity trading is actually just as easy as trading normal stocks or options. You could also gain exposure to commodities through exchange-traded funds (ETFs). But sticking with futures and futures options contracts is the way to go if you want a pure play on the actual, physical commodity.
Commodities contracts trade on designated exchanges around the United States. The most notable are the New York Mercantile Exchange (NYMEX), the Chicago Board of Trade (CBOT), the Chicago Mercantile Exchange (CME) and the ICE Futures U.S. Exchange (formerly the New York Board Of Trade – NYBOT).
The first step is to open a commodity trading account with a registered commodity broker. This is no different than opening a stock trading account. And once your account is open, you can trade commodities the same way that you trade stocks – online or with a broker’s help.
Once you’re ready to go, my advice is to stick with trading futures options contracts. It’s the safest way, considering that futures contracts have open-ended risk.
Here are a few more reasons to consider using options contracts over just futures contracts:
- Options keep your risk limited at all times. But the gains can be unlimited.
- With options, you don’t always need to predict the future direction of a commodity to see profits. Seriously. (I’ll go into more specifics about this in a future article.)
- Options come in varying degrees of short-dated or long-dated expiration periods. So you can give yourself as much time as you need for your prediction to pay off.
That’s all for today! Stay tuned for my next article, where I’ll break down each commodity market and how they tend to move.
Ahead of the tape,