Commodity Trading Strategies

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Commodity Trading Strategies
January 25, 2021

Commodity trading strategy

Here a trader would look to buy a nearer future contract and sell one further out, in the same market. A breakout strategy waits for a security to move beyond levels or areas it has been unable to move beyond for a while until its price moves past that limit and reaches a breakout. In other words, breakout trading is an attempt to enter the market when the price of a stock moves outside a defined price range.

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A CTA could have many models they work with (the systematic component), but override final decisions at their discretions. Or one could be a practitioner of discretionary strategies, but use computers to analyze fundamental and technical data (the systematic component). Over the years a great many investors have had good success in the markets integrating both. Years of witnessing the perils of a long option only strategy as a commodity broker led to my disappointment and pessimism in regards to a strictly option buying approach to the commodity markets. Time decay and the tendency of markets to stay range bound work strongly against the odds of consistent profits with such a strategy.

Breakout trading

For example, if the average range in crude oil is $50 to $90 and the market has recently ascended past $90, trend followers might buy crude oil futures potentially profiting from the trend higher continuing. Though energy markets carry some slight nuances compared to equities, most stock strategies translate to commodity trading. The buy-and-hold strategy is relevant for anyone looking to profit from a long-term upward trend in a commodity market, and the flip side of this strategy, sell-and-hold, can be equally intriguing. While some traders might choose to avoid trading energy commodities due to their high volatility, many try to take advantage of these large movements. For example, crude oil and natural gas have been prime candidates for both trend-following and contrarian trade strategies in recent years given their massive swings.

How to trade in commodities for beginners?

Commodities are traded on certain exchanges, and traders aim to profit off the changes in the commodity market by buying and selling these commodities. Commodity trading for beginners can be made easier with Contracts For Difference (CFDs), which is one of the most straightforward trading options in commodities.

Traders are improving their ability to hedge and speculate by developing code that more nimbly identifies trades and executes them across a broader set of tradable instruments. A systematic CTA usually makes trades based on models or computer programs. These signals could be based on technical analysis using charts, trend following, momentum indicators, and stochastics.

Technical strategy

There have been many books written on options on futures trading, however I sometimes question the usefulness of the information provided. In my opinion, the practice of repackaging stock option trading strategy and theory in an attempt to appeal to and educate commodity traders can be misleading. Additionally, there are large differences between option theory and option trading. Some of what looks good on paper is difficult to execute efficiently in the real world, this is especially true in the world of commodity option trading.

  • For example, it is incredibly difficult to analyze global satellite imagery to identify precisely the daily flow of commodities, given the frequency with which images are being taken.
  • By law, we must provide investment advice that is in the best interest of our client.
  • If you are planning to trade commodities, it’s necessary to know that trade wars have triggered a new paradigm shift in what drives commodity prices.
  • You’ll have the chance to gain valuable experience with these strategies and see what works best for you.

This is because investors move their cash to gold which is now regarded as a safe haven. The privacy and protection of your data and information provided to us is of vital importance. Sharekhan Comtrade Private Limited shall ensure to safeguard the security and confidentiality of any information you share with us.

Can commodity futures be profitably traded with quantitative market timing strategies?

These can include everything from extreme weather to geopolitical developments. The cost of shipping, rail and truck freight can affect commodity prices. In addition, disruptions to transportation, for example due to bad weather or drivers’ strikes, can lift commodity prices at the intended destination.

When the dollar falls, commodities become cheaper for overseas buyers and increases demand. Historical evidence suggests that rice might have been traded around 6,000 years ago. There is evidence that around 4,500 BC, the Sumerians used clay tokens as a form of money to buy livestock. The odds of being able to successfully navigate your way through price runs like that are slim and none. Trend-following strategies have a potential to do well with commodities, given that their trends can last weeks, months, or even years.

How to trade commodities?

A commodity can be categorized as any primary resource, such as crude oil, gold, or corn, that can be bought and sold with relative ease. The commodity asset class can be similar to the stock market in that commodities as a whole tend to travel in the same direction in the long term while specific assets will fluctuate more or less than others. For example, gold and crude oil might both be higher in a given year, but crude oil could outperform gold by multiple percentage points since energy commodities tend to be more volatile than metal commodities.

Spread trading involves taking opposite positions in the same or related markets. A spread trader always wants the long side of the spread to increase in value relative to the short side. This means the spread trader wants the difference between the spread to become more positive over time. The price is figured by subtracting the back month from the front month. For a more in-depth explanation, please visit our Introduction to Spread Trading page.

Moments-based spillovers across gold and oil markets

Exchange-traded funds (ETFs) do exist for commodities like crude oil, but they often directly track the futures and thus carry a degree of separation between the trader and the actual commodity. “Commodity trading on margin can result in higher profits than the stock market, but due to the leverage used, it can also result in higher losses,” Turner says. Small price fluctuations Commodity trading strategy may significantly impact your investment return, so there’s a lot of room for gain in the commodities market, but there’s also a lot of room for loss. This implies you only put down a portion of the investment’s overall cost. For example, instead of putting down the entire $75,000 for the full value of an oil futures contract, you may put down 10%, or $7,500.

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However, unexpected weather conditions, such as a drought can affect the prices of grains and a warm winter, may drive the prices of heating oil lower than expected. In such conditions, trading the actual contract is riskier, not just because of higher margin requirements but also because the position is essentially unhedged, which may lead to higher losses and potential margin calls. Risks may therefore be better managed by trading a futures spread instead of an actual contract. Producers of commodities and commodity trading companies trade commodities; commodity traders sell their goods to customers (sometimes manufacturers) for cash and to those who want to trade commodities. When people with an aptitude for finance got involved and created new trading strategies, commodity markets became more attractive.

How profitable is commodity trading?

Finally, in commodity trading, it is just as easy to profit from selling short as buying long. There are no restrictions on short selling as there are in the stock markets. Having the potential to profit just as easily from falling prices as from rising prices is a major advantage for an investor.

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