This week I received my first email from a trader in the Czech Republic. It would never have occurred to me that folks in the Czech Republic would be interested in the North American commodity markets, but apparently, to a few traders anyway, they are. I guess I shouldn’t be too surprised however, as in the past I’ve also received emails from traders in such exotic locals as Australia, Bermuda, Costa Rica, South Africa, the Philippines and even Louisville, Kentucky (that one’s for you Paul J).

I think I’m going to get one of those big world maps and start putting pins in it for every email I get from a different part of the world. Hearing from traders in so many different countries has made me realize that commodity trading truly is a global activity, and why not? As Ken Robert’s is fond of saying: it’s the world’s one perfect business; no staff, no customers, and no inventory.

This fact is really beginning to hit home as my wife has recently sold her property management business. After a few weeks away from the day-to-day pressures of running the business you really begin to appreciate the freedom that the trading business gives you. Does this mean that trading is easier than a traditional business? No, of course not. In fact, being successful at trading requires as much work as being successful at any other business (and maybe more). This important point escapes many new traders and can be at the root of their failure.

There is a lot of study and practice involved in becoming a successful trader, and while there are no real short cuts, the end results are worth the effort. It is my sincerest hope that this little weekly publication can, in some small way, help you become a better trader.

Hope you enjoy this week’s issue.

Erich

Corn fell like a rock last week after breaking through the support at the 246 level. Once below here the market continued lower blowing through the next two support levels at 243 ½ and 239 ½ before closing near the low on Friday. From here is appears that the market is poised to go lower still with the next support level to be found at 232 ½. There is an old gap below here which might be re-filled in which case we could see the market fall to the 229 ¾ level. If the market continues lower still, look for it to test support at 227 ¾ as well.

Although the market is extremely bearish at this point in time for the short term, the weekly charts are still technically in an uptrend. If the market finds some footing around the 235 level, which coincides with resistance found on the weekly charts from July of this year and the 40 period Moving Average, it might reverse and head higher. As mentioned however, the market is in a short term downtrend so you will want to keep a close eye on any long positions to make certain that the market is really heading higher.

Next week we will be shifting our attention to the March contract.

Well cotton had quite a week. After gapping past the resistance we outlined it proceeded to make a new four month high on huge volume before pulling back and covering Monday’s gap later in the week. Cotton will likely continue higher in the next few weeks; however we might see the market pullback a little next week before doing so.

There is resistance immediately above Friday’s high at 4900. Above here we have the recent highs of 4980 and 5010 to contend with as well. If the market can post a reasonably strong close above the current high we should see prices continue to the next resistance level at 5100.

While I would not expect much in a downtrend next week, if the market did decide to pullback more it would first test the support at the 38% level of the October to November uptrend at 4700. If the downtrend was strong enough we might even see cotton pullback to the 50% of the recent uptrend at 4606.

Next week we will be shifting our focus to the March contract.

After breaking above the rounded bottom formation, beans rallied only to be turned back by the resistance in the 577 range we pointed out. >From here they fell to the 62% level of the last four week uptrend before finding support. Now that the market got this little pullback out of the way it looks as though it might be poised to continue higher next week.

A close above Friday’s high should see the market once more challenge the resistance in the 577 ½ - 580 range. A close above this level will likely see prices continue higher and challenge the contract high at 593 ½.

Friday’s trading saw the market close very near the low of the day. If beans should continue lower next week look for them to test the support at the 50% level at 553 ¾ and support at the 38% retracement at 547 ½ before possibly falling as low as 539 ½.

Last week saw cattle stuck in a range between a high of 7325 and a low of 7235. We can use this range to bracket a trade for next week to let the market show us which way it wants to go.

Above the top of the channel at 7325 there is more resistance at 7360 and 7380. After that there is significant long term resistance at 7445. A break below the bottom of the channel at 7235 could see the market test the nearby support at 7180 before trying the support at the 62% retracement level of the uptrend at 7164. If prices continued to slide there is more support at 7135 and the 50% retracement at 7114.

Next week we will be shifting our attention to the February contract.

After struggling with the long and short term support around 1800, cocoa gave up towards the latter part of the week and headed higher. Although the market is in a short term downtrend, it maybe setting up for a larger pullback next week, or perhaps even a resumption of the long term uptrend. Keep in mind that any serious bullish move will require an increase in both volume and open interest if it going to be sustained.

If the current lows of 1788 hold, look for cocoa to challenge the resistance level above Thursday’s high at 1925. Above here the market will try to get above the resistance at 1967 and 2023 after which it might be in a position to simultaneously fill the gap of October 17-18 while retracing 50% of the recent downtrend at 2097.

As mentioned the market is in a downtrend for the short term. If prices fail to exceed Thursday’s high look for them once more to test the support at 1788-1800. If the market can post a strong close below this level it will next test support at 1765 and 1720 before completing the large daily 50% at 1681.

Next week we will shift our attention to the March contract.

Early in last week it looked as though sugar was going to charge up to complete the 50% retracement of the weekly trend at 790. However, long term resistance at 777 halted the uptrend sending the market down a few points by the end of the week before finding support at 738. This appears to be a short term pullback and we could very likely see a continuation of the uptrend sometime next week.

While the market might head a little lower before resuming the uptrend, there is a fair amount of support below Friday’s low to hold the market up. The first support is found at 730 followed by more support at 717 and 707. If the market fails to rebound off these levels look for prices to continue to slide to support found at 684-689.

The Swiss Franc continues to trend higher. As the threat of war in the Middle East increases, watch for foreign currencies to head higher. Last week saw the completion of a rounded bottom formation just shy of the contract high. We can use this formation to trade from next week.

A break above the neckline should see the Franc challenge the current contract highs at 6986. Above here there doesn’t seem to be too much resistance until the long term resistance found at 7080. The market has not had a recent pullback however, so we might expect prices to retreat a little next week. The first level of support is found at 6848 followed by support at the 62% retracement at 6796 and the 50% at 6748.

Silver remains trapped below the neckline of the rounded bottom formation we pointed out last week. After pulling back slightly the market made another run at the upper resistance managing to poke through briefly on Friday. A close above the neckline at 457 should see the market continue higher. The next resistance is found at the 38% retracement level at 462.75, after which there is more resistance at 469.50, 472 and the 50% retracement level of the last downtrend at 473.75

If silver fails to close above the neckline of the rounded bottom formation look for prices to continue to range off support at 444-447. If prices manage below this level they will find more support at 440, 433.50 and 428.

Next week we will be focusing on the March contract.

It is a common misconception that you need to follow a lot of markets to be a successful trader. This is not true. I know some traders that follow no more than three markets, yet manage to find ample trading opportunities among those three. For most traders, choosing six to eight markets to follow should be adequate. It is important to allow some diversification among the markets you follow however, so as to allow for the maximum number of trading opportunities.

You would not want to choose all grain markets to follow, or all meats, as the markets within each category tend to move together. By taking one or two markets from each category you should have enough of a cross section to catch most of the opportunities within that category.

Therefore when deciding which markets to follow you might want to choose one or two grains, a meat market, a couple of softs and maybe even a currency. Just a word of caution: I would not recommend following feeder cattle and pork bellies for the beginning trader as these two markets can be very wild. Likewise you will want to stay away from the exotic markets like lumber, rice, oats, platinum and palladium which can be very thinly traded.

If you are trading with a smaller account you might want to gravitate towards those markets with the smaller margins as well. There is no point learning the intricacies of the crude oil market if you do not have enough money to margin a contract. While a margin is only a deposit and the amount of money you risk per trade is determined by your stop loss, smaller margin markets will make it more feasible for you to trade multiple contracts. The ability to take multiple contracts when needed allows you to profit on smaller market moves while risking less money.

We have all heard the demoralizing estimates that 90% of new traders never make it to their second year of trading, but did you know that the National Futures Association has also documented that it takes approximately 5 years and $35,000 to become a successful commodity trader? So what is the small trader, who doesn’t have 5 years experience or $35,000, to do? As with almost anything in life, persistence and hard work separates the successes from the failures.

You don’t always have to devote a lot of time to your trading, but it is important that do you put in time to learn how to trade. Remember, trading is a business. You probably spend at least 40 hours a week being good at your day job; therefore it is unreasonable to assume that you can just start trading and immediately be good at it without first learning the business. Fortunately however, learning to trade does not require quite as much attention as your day job. In most cases you can study and learn trading in about three to seven hours a week. An excellent starting point for the new trader is the Common Sense Commodity course you’ve heard me mention before. If you are just starting out trading I encourage you to look into it. You can get a free preview of the course here.

Next: papertrade, papertrade, papertrade. I know there is a lot to be said for the value of learning with real money, but if you can not produce consistent results with your papertrades, chances are good that you will just end up another statistic down the road. You should continue to paper trade until you are consistently right about 75% of the time. Some folks like to use an arbitrary time frame of three months to test their trading abilities before hopping into the markets; but I would rather see you set a number-of-trades target (ie. 50-100) to test your trading ability before trading with real money. This will give you a better idea as to true trading ability.

Having a mentor, someone you can ask questions of, is also important to the new trader. Fortunately a commodity forum, such as Traders Helping Traders allows the novice to ask advice of experienced traders and brokers. Remember what your Mother said: the only dumb question is the one that goes unasked.

Finally the last ingredient the new trader can use to improve their chances of long term success is to set trading goals. Very few traders ever consider setting financial and time frame targets for their trading, yet this often overlooked component can be the final straw between success and failure. Setting goals will determine how aggressive or passive you intend to be with the markets. It will give you an idea as to how much you want to earn daily, weekly, monthly with your trades. It will help you get a better perspective of what you want from your trading, which will help sharpen your focus, which will translate into a more serious businesslike attitude towards the markets.

This week’s question:
How much real money did you, or do you intend to, start with?

I am aware that the stop loss placement is critical to preserve our trading accounts, but I'm curious why I should or should not use an option to insure a position against a loss as opposed to a stop loss?

Answer:

This is an excellent question. The greatest benefit of using options instead of stop loss orders is that an option will allow you to “ride” a market that is trading wildly. For instance, the large ranges that can be encountered in the meat markets make it difficult to place good stop loss orders without being stopped out prematurely. You might have chosen the correct market direction, but the large swings the market makes can take you out before you can realize a profit.

In an instance like this you might be better off using an option that takes a position opposite your futures contract as stop loss protection. However there are many more variables to be considered when using an option as a stop loss making it more complicated than simply using a stop loss order.

One problem with using options as stops is liquidity. Since options normally expire about a month before the futures contract comes due, you might not be able to trade the more liquid front month contract if the options have already expired. This means you will need to consider a further out contract that would still have options available. It is possible to combine options and futures of different months; however this strategy, known as spread trading, is not quite the same as using options as stop losses.

By trading a further out contract you could be trading a less liquid market while paying more of a time premium for your option as well. This makes it important to consider the intended length of your trade. If your trade is only for a short term (ie. days to weeks) you might be better served by a stop loss order; however if your time frame is one of several weeks to a month or more, an option would allow you to ride the market swings without having to worry too much about stop loss placement.

Choosing the correct option as a stop loss is also a bit of an art and should be done in consultation with your broker. Ideally the options whose strike prices are trading closest to the money offer the greatest protection as they appreciate fastest if the market moves against you. Unfortunately these options are also the most expensive, so much so that even if you risk only a portion of the option premium in the trade, you might be putting more money at risk than if you used a large stop loss. Using an option with a strike price that is further out of the money might be cheaper, but it will also appreciate less quickly, thereby inflicting losses on your trading account until the market reaches the option’s strike price.

Remember, the purpose of any stop, whether it is a stop loss order or an option, is to take you out of a trade that is not going as you had planned. By using an option, many traders might be inclined to hold on to a losing position too long, instead of exiting and looking for other opportunities elsewhere. This is why it is important to have a trading plan, one that outlines where you expect the market to go, and more importantly, how far you will allow the market to move against you before you exit your position, whether you decide to use stop loss orders or options.

There are several excellent trading strategies that combine the use of futures and options; however for stop loss purposes, depending on the market you are trading and the time frame of your trade, you might find that a regular stop loss order is easier to implement, cheaper, and easier to manage than using options.