Once a Futures trader has been trading the Financial Futures markets for a while they may want to begin trading the physical Commodity Futures markets. There should be no hurry to trade these physical products until you have a very firm understanding of the Futures markets in general. After all, these markets have been around for over 100 years, I am sure they will be here when you are ready.
In this article I would like to show you a checklist for setting up a swing trade in the Commodity Futures markets. You do not have to use all of these steps, but they are to give you some guidelines in structuring your trading plan to create consistent trading setups.
Look for a Seasonal Pattern to Trade
While a trader could just scan their charts for a market to trade I think using Seasonal Patterns as a starting point and a Commodity Screener gives you an edge. There are so many Futures markets to trade and trying to find one that is ready to move can be a challenge for most traders.
There are a few companies that offer research on Seasonal Patterns for both outright (long or short) positions and Spread trading. Moore Research Center (MRCI) has been around since 1990 and well known throughout the Futures industry. Each month they offer their current research on approximately 15 Seasonal Patterns for all Futures markets. They also include another 15 Seasonal Spread research reports. Each of the research reports will reveal a market that has moved in some consistent cyclical pattern at least 80% of the time or higher over the last 15 years. Notice I said Ã¢â‚¬Å“researchÃ¢â‚¬Â and not Ã¢â‚¬Å“recommendations.Ã¢â‚¬Â These are all historical analysis attempting to anticipate what will happen in the future with some sense of consistency.
MRCI still has a two week trial offer for all OTA students. If you feel you understand how to trade using OTAÃ¢â‚¬â„¢s core trading strategy of Supply/Demand levels then perhaps this research could be of value to you.
Using the 15 markets that have been researched each month a trader can begin to apply their technical and fundamental analysis to a specific market that has a higher than average probability of moving in one direction or the other. For Spread traders it identifies both legs of the Spread (which market/month to buy and which market/month to sell).
Not all of the markets that have been researched will be traded. Sometimes there are factors that will keep you from trading that market. Example: trade is against the trend, market does not reach your level to get your trade filled, some fundamental event in the market may be distorting the Seasonal pattern this year, etc.
Check the Fundamentals for a Discrepancy with the Seasonal Patterns
This implies doing a little research about the market you are trading. Remember, Seasonal Patterns were calculated with data and events from the past. If you see a Seasonal Pattern that you may be interested in look to see if there is anything happening this year that might have an impact on the research.
This could be weather, which is one of the biggest disruptions in even the best Seasonal Patterns. Remember the summer of 2012 and parts of the Country were experiencing the worst drought in 50 years? Or this year the Natural Gas market has rallied very strongly due to the extreme cold weather (potentially the coldest in 20 years) in the Northeast part of the Country. Being aware of these stats would keep a trader from selling a Seasonal Pattern in these two markets. If the weather was only cold for a day or two and we had this spike in Nat Gas prices then perhaps a Seasonal Pattern sell would work, but not when the weather could become a record breaker.
Metals markets need to be aware of major mining strikes and geo-political events. Energy markets might want to pay attention to extreme situations in the Middle-East or countries like U.S.A., China or India showing signs of significant economic expansion or contraction. The key is being aware of your markets environment. You do not have to micro-manage this information, just beware of significant events.
Look Up the Margin Required to Trade
This information is found on the Exchange website your Futures contract will trade on. Your Futures broker website also will have a list of the margin required to hold these positions overnight. Depending on the volatility and risk of the market you are planning on trading will determine how much capital will be required for margin. Futures Exchanges will set these margin rates based on the above mentioned risk and volatility.
Consider Using Options if the Margin is too Expensive
If the overnight margin is too expensive then consider buying Call or Put Options. These have limited risk and unlimited reward. I would strongly recommend you understand how the Options market works before entering this arena. There are so many moving parts to an Options trade that entering this blindly will most likely lead to a loss.
Does Your Market Have Daily Limit Moves?
Check the contract Specifications page for each market you are going to trade to be aware of this rule. Limit Moves can be very expensive if you are on the wrong side of one.
Calculate How Many Contracts to Trade and Maximum Loss to Accept
Depending on your account size the amount of Margin will determine how many contracts you can trade. If your account size is a little larger here is an algorithm you can use to determine your number of Futures contracts to trade:
Number of Contracts to Trade = (Account Size $ X Risk %) / (Stop Loss $) = Maximum number of contracts to Trade
$15,000 X 1.5%= $225 / $175 = 1.28 Maximum Contracts to Trade
Determine how much of your account you are willing to risk for each trade. Some traders use between 1 and 2% of their accounts per trade. In the above example the trader decided to use 1.5%. After figuring out the dollar value of 1.5% of their account they were able to divide that amount by the size of risk this current trade will be (their protective stop). The trader will be able to trade 1.28 contracts using the risk management technique described here. Since all Futures contracts trade in whole numbers, you will have to find a rounding technique that works for you.
Research Any Reports Due Out That May Impact Your Trade
Most traders are aware of the major Economic reports that come out every month and their release dates. But the physical Commodity markets reports are a little harder to remember. For this you will need a source for both Economic and Physical Commodity reports. Here are two that will help you:
Economic Reports- www.forexfactory.com
Commodity Reports- http://www.insidefutures.com/calendar/
The Grains, Livestock, Energy, Softs all have monthly supply/demand reports that can cause very fast market conditions thereby increasing risk to a novice trader.
Observe Price Structure and Look for Contango or Inverted Markets
A market in Contango (Normal Market) will have lower prices in the front month than in the back months. Prices will appear to be ascending from one month to the next in the Commodity cycle. This type of market typically does not show any major demand for that Commodity at the current time.
A market that is Inverted (Backwardation) will have higher prices in the front month than the back months. Prices will appear to be descending from one month to the next in the Commodity cycle. This type of market typically has a perceived shortage of the particular Commodity and it is being distributed immediately instead of storing it.
Check the Commitment of Traders (COT) Report
This report breaks down the positions that are held by Commercials and Speculators based on Open Interest. Revealing their net short or long positions can be helpful identifying when a trend may potentially start or end. Commercial traders are usually the most-long at market bottoms and most-short at market tops. Large Speculators are usually the most-long at market tops and the most-short at market bottoms. Large Speculators are trend followers usually causing this result.
Using extremes of both groups trading positions can tell when a trend is overextended or perhaps beginning. When trading Seasonal Patterns we would like to see the Commercial traders in alignment with the Seasonal Research. Considering the Commercials use the Commodity on a daily basis they most likely have created the Seasonal Pattern in the past.
Confirm the Contract Month You Are Going to Trade Has Time Before Expiration
All Futures contracts will eventually expire. When a trader finds a Commodity Futures market to trade they must be aware of when the contract will expire. This can be done on the Futures Exchange website or the Commodity Report calendar mentioned above. If you are getting into a trade make sure you have several weeks before the contract expires. If the contract will expire soon then place your order in the next contract month of the cycle. This will eliminate the trader having to rollover their position when the current contract expires very soon.
Look at Multiple Time Frame Charts to Identify the Trend
Use a top down approach and start with the monthly, then weekly, then daily chart to determine the trend of the market you wish to trade. This is very important because the trend is your friend. Combine a trend with a Seasonal Pattern and you just increased your edge for this trade.
Identify Supply (Resistance)/Demand (Support) Zones
Once you have determined the trend of your market then you are ready to find your entry points on the chart. This is done by applying OTAÃ¢â‚¬â„¢s core strategy of Supply/Demand levels in the context of your trend analysis. Using these levels creates qualified entry points as well as logical stop placements. When looking for your levels keep in mind that the larger the timeframe the level is found on the stronger it will be. Rarely will a trader be using 5 or 10 minute levels to setup swing trades in Commodity markets.
What Will Be Your Entry Style For This Trade?
The obvious style will be placing your bracket order to buy or sell usually done with limit orders. This will include your entry price, protective stop and your profit objective if you choose to use one. These orders will be linked so one order will cancel the others if filled. Make sure to set your orders as Ã¢â‚¬Å“Good till CancelÃ¢â‚¬Â on your order platform.
Or some traders may prefer to use a confirmation style order. Allowing price to come into their zone and enter as the market leaves in their intended direction. This helps the traderÃ¢â‚¬â„¢s confidence to see the price moving in the anticipated direction.
Determine How You Will Protect Your Money
Determine if you will use a protective stop to manage your risk in this trade. Or will you use an Option position to manage your risk instead? Some traders will also use Spread positions to manage risk in open trades. You should answer this question in your trading plan before you enter the trade. Never make decisions after you get into your trade, always have a plan.
How Will You Elect to Exit Your Position?
Will you enter the market with all of your contracts at one price and also exit the market with all of your contracts at one price? This is referred to as All In, All Out.
You might want to use the All In approach and scale out at different profit targets. This is referred to as All In, Scale Out.
You will need to decide if you will use fixed profit targets or will you use a trailing stop to protect your profits letting the market trend give you more profit?
These are some ideas a Commodity Futures trader may want to incorporate into their trading plan. Most Seasonal trades will be held for a series of days to weeks. Due to the volatility of the Futures markets most of the time the market reverses direction quickly rather than trend for any period of time. Taking profits at your targets is sometimes better than trying to stay in a Seasonal Pattern trade until the optimal exit date. On a few occasions a market might begin a major trend when a Seasonal Pattern occurs. These trades are the ones you want to hold onto if you can.
Plan the trade, Trade the Plan
Ã¢â‚¬Å“A warrior never worries about his fearÃ¢â‚¬Â Carlos Castaneda