As the term implies, commodity trading is better used to describe the commodities markets than commodities investing. The reasoning is that commodities typically do not increase over time like stocks do. Therefore, most people will take a trading approach with commodities to achieve higher returns.
Historical Commodity Prices
Looking at price charts of most commodities it is easy to see that there is no gravitation for higher prices over time. In fact many commodities have stayed in a range since the mid 1970s. Oppositely, the prices of stocks have had a steady rise in prices. Therefore, it would make sense to implement a buy and hold strategy for stocks and implement a commodity trading strategy for commodities.Commodity Trading Comparison
Commodities do not pay dividends; in fact they actually have a slight decline in price over time due to carrying charges. From 1975 to 2003 the CRB Index ended almost unchanged. An investment in commodities from this period would have netted almost no returns over a 28-year period. The commodities markets finally had a big move where the commodities index more than doubled from 2002 to 2007.Many commodity traders and managed futures funds that specialize in commodity trading have made excellent returns for decades. In fact, the Barclays CTA Index has had an average annual return of more than 13 percent from 1980 to 2007.
Commodity Trading Strategies
There is almost an infinite amount of commodity trading strategies that traders can use. Commodity traders will normally design a trading plan with a strategy that suits their risk tolerance, comfort levels, knowledge of the markets and various other parameters.Two of the most popular trading strategies involve either a trend following approach or a range trading approach.
Trend Following – This is a commodity trading strategy that most professional traders use and recommend. The theory is that prices that are in a trend have a higher probability of continuing in that direction. Therefore, the odds should be in your favor by taking trades in the direction of the trend.
Range Trading – Markets are often not in a trend, so a trend following strategy may not be as profitable under these circumstances. Under a range trading strategy, you would sell the market when it gets to the top of its range and buy the market when it gets to the bottom of its range. This strategy can work very well for a long period of time, but you have to be careful when the market breaks out of its range.
Both of these commodity trading strategies have their benefits and shortfalls. It is also possible to use a combination of both strategies. Trend following strategies are dependent on having a couple of big movers each year. It is imperative that you do not miss one of these big moves.
With range trading, you can be lulled into a sense of security that the market will stay in its range. Eventually, one of the markets will break out of its range and have a big move. This is usually the situation where range traders lose big. They hold onto a position thinking the commodity market will fall back into its range and it just keeps moving against them. Or worse, they add to their positions and really make things bad.
Regardless of which basic strategy you use, discipline and money management are essential. Make sure you trade with stop losses and do not risk too much on any one trade – no matter how good it looks. If you want to make above average returns over the long run, you will need to implement a commodity trading strategy instead of a buy and hold strategy with commodities. However, if you do not have a sound trading plan, do not expect a promising outcome.
