Which commodity is good for beginner trader?

General discussions about futures.
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hlpsg
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Which commodity is good for beginner trader?

Post by hlpsg » Sat Jul 10, 2004 9:25 am

Hi
Would like to hear your thoughts on which commodity a new trader should start off in, and why.

Hopefully one which is "safer" in that making some mistakes will not cost you your entire fortune.

This will also mean less leverage, a lot of volume and decent volatility.

Thanks!

richard
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Post by richard » Sat Jul 10, 2004 10:00 am

one with a lot of liquidity. Corn or wheat, or live cattle. If you are new you can trade one contract. There are mini ag contracts but they do not trade with much liquidity.

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"Safer" commodity

Post by ksberg » Sat Jul 10, 2004 11:56 am

I agree with Richard: stick with one-lots and look for liquidity. It probably is also easier to also start by focusing on one market. I would shy away from highly volatile markets.

But, just like a Volvo might be safer than a Ferrari, it's the guy behind the wheel that ultimately makes the biggest difference (more so than the vehicle). What you can do is ensure you have a sound approach and are prepared and ready to trade. If you are a discretionary trader, realize that the human mind is your biggest enemy: the Reticular Activating System (RAS) is designed to see patterns that support your point of view (and miss those that do not). If you are a systems trader, back-test are ensure you see a consistent "edge" for expected returns (literally reward/risk expectancy). In either case, include a review of historical price shocks to prepare for the worst, Sizing the account for worst-case can help the mental preparation.

I have a question: Is the notion of "safer" commodity focused on what can happen on a single trade? I see I have pointed out issues that tend to be cummulative, which I believe have the biggest impact for any account.

Cheers,

Kevin

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Post by damian » Sat Jul 10, 2004 3:00 pm

Yes, look for liquidity, small tick size, lowish volatility. There are a few and some have been mentioned. For no good reason I like the Eurodollar contract (ED, not the currency). One advantage that you have the ability to trade an expiry that is 12 months away from delivery so may avoid rollover and all that it brings.

Keep in mind that you can lose as much money on this contract as any other and to be sure some people have been put out of business by this very contract (some big CTAs short in late Oct 87).

A 'good' contract may also be a function of the type of trading you want to do and the strategy you employ.

Regardless of what you choose, in the end you will learn a lot by actually trading so all the best!

Demon

Post by Demon » Sun Jul 11, 2004 3:47 am

Hlpsg, my advice would be not to trade just one market if you are going to adopt a mechanical trading system. I think the adive about the mini's is spot on if you are starting with a small account size, but I would look to build a portfolio of uncorrelated markets eg. corn, crude, t-note etc. Although you may not believe what I say, providing you have sufficient capital to trade say 6 to 8 markets, in my opinion it would be less risky than trading just one. If you don't have sufficient capital for that, my advice would be to wait until you do, but contiue to study and start to test today.

All the best.

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Post by hlpsg » Sun Jul 11, 2004 4:19 am

Thanks for all the feedback.

Richard, you are saying do not trade mini-corn/mini-soybean etc because of low liquidity, is that right? Thanks.

I have another question I hope someone can answer, from the CBOT website, regarding soybean trading, it says:

Daily Price Limit
-------------------
50 cents/bu ($2,500/contract) above or below the previous day's settlement price. No limit in the spot month (limits are lifted two business days before the spot month begins).

Does this mean that :
1) The commodities opening, high and low price for today cannot be more than $0.50 away from yesterday's closing price? So there is no risk of the commodity suddenly opening $4 away from yesterday's closing price because of some event that happened in the night?

2) So for a contract that takes delivery in December, if I get out by end of October, I will never have to worry about losing more than $2500 overnight (unless liquidity was really bad)?

I think my understanding is wrong, because if I look at a S2004H (Soybean Expiring Mar 2004) contract, on Nov 19 2004, the close was 743.25, on Nov 20 2004, the open was 744.00.

So the difference between 20/11 open and 19/11 close was 0.75, which is bigger than the 0.50 limit?

Thanks for any light you can shine on this!

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Post by richard » Sun Jul 11, 2004 12:22 pm

I don't trade the corn or wheat mini contracts because the action is in the pits with regard to those commodities. Same with mini beans.

A daily limit means that if the commodity drops "limit down", say, trading is stopped until the next day.

In some times in the past, commodities have been limit down for a number of days in a row. It would be very hard or impossible to close a position in that case while limit-down conditions prevailed, and you could end up owing your broker a good deal of money. This isn't common but it has happened.

The biggest mistake people make trading commodities is trading too many contracts, and not having protective stops in place. Protective stops should cover you in event you are wrong about your trading idea, or if there is a reversal in the market and you would otherwise lose a great deal of money. Protective stops don't always work, though. Futures can "gap down" and your stop will be executed at a much worse price than you could imagine.

I had this happen to me with coffee recently, because coffee gapped down and my stop executed after a move that was about limit down for the day. Also, I was caught long in cattle when a mad cow scare happened a few weeks ago and cattle gapped down on the open, so my stop got executed at a big loss.

However, that is the risk you take with futures. If you don't trade too many contracts you won't be wiped out or anything near.

Here is what I do. I look at an average of medium-volatility bars over the past year and I multiply by 2 and assume that would be my possible loss. If my money management rules allow for that loss, then I trade accordingly.

For instance, if a medium volatility bar is 1 cent, I look at a 2 cent move and multiply by the value of a cent in that contract, for instance $400 for cattle. So if my stops get missed due to a gap move, $400 X 2 = $800 would be the loss I would face at the most, in a typical situation.

This is just a rule of thumb -- I could lose everything if cattle gaps down a number of days limit-down, but as I say that is rare.

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Post by hlpsg » Sun Jul 11, 2004 7:27 pm

Thank you Richard. I was very uncomfortable with this uncontrollable risk and being a new trader with limited capital, I really will not be able to trade because one large drop down will wipe me out. So my original plan was out, because backtesting shows my current capitalization will not be able to withstand a drop down if it happened immediately after I started trading. I also want a good night's sleep.

So I went to read up on options, and although very expensive, it is a guranteed way to limit my risk, is it not? So in the case of a huge drop down like mad cow disease or mad corn or wheat disease or a freak fire etc. all I will have to worry about is the price of the premium I paid for the option?

For eg. instead of buying my futures at a certain price, I tell my broker to buy an at-the-money option once the futures price hits 250.00 and sell the option if the price hits 249.50 (or excercise and take the loss whichever costs less). So I have my stop loss in place, but also if the next day the price of the futures drops a crazy amount I will just lose the $500 or so I paid for the option.

Is this a viable plan? Assuming of course the prices of the options will still be covered by the trading profits.

Thanks!

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Post by richard » Sun Jul 11, 2004 9:01 pm

You can certainly trade options instead of futures.

Options are however rather illiquid and thinly traded. This means you have quite a spread between buy and sell prices, so you take a bath in transaction costs (slippage), making them less than workable for short term trading at least IMHO.

They work best for longer term moves because if you buy and sell options too often you end up losing your principal through slippage.

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Post by TC » Mon Jul 12, 2004 12:16 am

hlpsg,

If you think it is risky to speculate on futures think twice before venturing into options. Before settling on a diversified portfolio of futures markets I did consider options. Two observations struck me:

1) If I think determining the direction of price is hard enough what reason do I have to believe I can be right not just on whether the price is going up or down but also WHEN this price move will happen !!

Ask yourself if you are able to predict not just which direction a market will move but the timing of such a move. Adding in the timimg issue adds an order of magnitiude to the risk in my opinion

2) It seems that most of the smart money in options is in writing the options rather than buying them ie collecting the premiums and waiting for most of them to expire worthless

As always there are many successful options traders who can argue the other side, and you may become one of them, but I believe there is much easier money to be made elsewhere

If capital is limited try a diversified basket of e-mini futures contracts. You can always tackle options when you have become more familiar with the underlying markets.

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Futures correlation studies

Post by traderDJ » Mon Jul 12, 2004 6:39 am

Newbie trader here looking to get into futures shortly.

Still writing my trading plan, and about to start backtesting mechanical systems, but I'm trying to decide on my portfolio of futures.

Recognising that, for example, Eurodollars, cattle and oil are likely to be uncorrelated markets, is there anywhere I can find correlation statistics for a wide variety of futures?

Haven't had much luck yet finding a concise correlation matrix for futures.

Cheers for any help.

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Post by hlpsg » Mon Jul 12, 2004 6:42 am

richard wrote:
In some times in the past, commodities have been limit down for a number of days in a row. It would be very hard or impossible to close a position in that case while limit-down conditions prevailed, and you could end up owing your broker a good deal of money. This isn't common but it has happened.
Richard, so you are saying that although there is a limit to how much the future can fluctuate wrt prev day's close, however, because of lack of liquidity your losses would be much greater because no one is willing to buy your contract?
richard wrote: Futures can "gap down" and your stop will be executed at a much worse price than you could imagine.
Richard, this gap down you refer to is the difference between today's close and tomorrow's open?

Thanks for the education!

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Post by hlpsg » Mon Jul 12, 2004 7:03 am

TC wrote:hlpsg,

If you think it is risky to speculate on futures think twice before venturing into options. Before settling on a diversified portfolio of futures markets I did consider options. Two observations struck me:

1) If I think determining the direction of price is hard enough what reason do I have to believe I can be right not just on whether the price is going up or down but also WHEN this price move will happen !!

Ask yourself if you are able to predict not just which direction a market will move but the timing of such a move. Adding in the timimg issue adds an order of magnitiude to the risk in my opinion

2) It seems that most of the smart money in options is in writing the options rather than buying them ie collecting the premiums and waiting for most of them to expire worthless

As always there are many successful options traders who can argue the other side, and you may become one of them, but I believe there is much easier money to be made elsewhere

If capital is limited try a diversified basket of e-mini futures contracts. You can always tackle options when you have become more familiar with the underlying markets.
Hi TC,
On (1), I plan to buy the option at-the-money (meaning if X is trading for 300 cents, and I get a LONG signal, I buy a long call option for 300 cents.
I may be missing out something but I don't quite understand what you mean by timing the move. Won't I have a right, if I bought a long call option for 300 cents, to buy the underlying future from the time I buy the option, till the option expires, at 300 cents? BTW I'm not trading a long term trend following system, so I'll probably be in and out in 1 week at the most so I won't have to worry about it expiring most of the time.

For (2) yes I understand the odds are against me, the market wizards also say people who know sell options, people who don't buy them. However I do not plan to use options for the usual purpose, buying a long call below current market price in anticipation for markets to go up. I'm only looking at options as a way to limit my risk and I plan to only buy an option once it reaches my "signal" price.

Kind of like in turtle rules, if you get a 50 day high breakout, instead of buying the underlying futures, you buy an option at the market price instead. That way if something disastrous happens, you only lose your premium. Of course your trading profits will have to more than cover the price you pay in options, and that's profits I'm willing to give up for safety, till I build up a big enough capital.

Correct me if I'm wrong (thank you), but I won't have to worry about options being illiquid as long as the underlying futures are liquid right? If nobody wants to buy my option, I'll just "excercise" it and make the profit. Of course then I'll lose the price of the premium I paid, but I've also included that in my backtesting. In fact I've given the leeway to always lose the price of my premium whether I make money, hit stop loss, or hit a move so bad it wipes out my trading capital had I been trading the futures.

I will definitely paper trade this for 6 months to 1 year before I start, but I really appreciate all the comments, corrections, insights and education all of you have given, and I'm looking forward to hearing more of your thoughts and experiences! Thank you for your time.

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Re: Futures correlation studies

Post by hlpsg » Mon Jul 12, 2004 7:08 am

traderDJ wrote:Newbie trader here looking to get into futures shortly.

Still writing my trading plan, and about to start backtesting mechanical systems, but I'm trying to decide on my portfolio of futures.

Recognising that, for example, Eurodollars, cattle and oil are likely to be uncorrelated markets, is there anywhere I can find correlation statistics for a wide variety of futures?

Haven't had much luck yet finding a concise correlation matrix for futures.

Cheers for any help.
traderDJ,
I thought I saw this capability in a software I downloaded but I can't be sure. I think it was at www.geckocharts.com , check it out.

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Post by richard » Mon Jul 12, 2004 8:18 am

I'm not saying people won't buy options, I'm just saying there is a lot of slippage involved -- the spread between buy and sell prices are quite high with options. Transaction costs in the form of slippage can be high enough to overcome your edge unless you are trading longer term, in which case you won't be entering and exiting positions often enough for it to be too damaging I would think.

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Post by TC » Mon Jul 12, 2004 11:29 am

hlpsg

If you are buying an option as a way to manage risk then that is certainly different from substituting stocks or futures with options alone. Using options as part of an overall risk management approach may have merits but in my experience it is expensive insurance and, for my trading at least, is not worthwhile as the benefits do not outweigh the cost and the added complexity.

As a general rule, I am very reluctant to modify my trading if it adds complexity. I am just more comfortable taking a small improvement that simplifies my trading rather than a potentially larger return that complicates it.

If you start using options for risk management purposes l hope you'll keep us updated on your progress. lf it works out well for you l may be inspired to look at the idea again in some more depth !!


Best of luck !

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Post by traderDJ » Mon Jul 12, 2004 1:20 pm

hlpsg

Thanks for the site recommendation - I'll have to take a look at that.

I am presuming you understand and have taken into account the implications of underlying volatility on option pricing and have factored that into your trading plan. I suppose this is where a robust money management system which adjusts for volatility could be very valuable, if not essential. I'd be curious to hear how you have tackled this.
On (1), I plan to buy the option at-the-money (meaning if X is trading for 300 cents, and I get a LONG signal, I buy a long call option for 300 cents.
I may be missing out something but I don't quite understand what you mean by timing the move. Won't I have a right, if I bought a long call option for 300 cents, to buy the underlying future from the time I buy the option, till the option expires, at 300 cents? BTW I'm not trading a long term trend following system, so I'll probably be in and out in 1 week at the most so I won't have to worry about it expiring most of the time.
Due to transaction costs, you wouldn't exercise your in the money option.
Kind of like in turtle rules, if you get a 50 day high breakout, instead of buying the underlying futures, you buy an option at the market price instead. That way if something disastrous happens, you only lose your premium. Of course your trading profits will have to more than cover the price you pay in options, and that's profits I'm willing to give up for safety, till I build up a big enough capital.
If something disasterous happens and you lose your premium, that's a 100% loss on the trade. Unless I'm way off on my understanding, options on futures are even more volatile than vanilla futures due to the extra leverage the options add. More volatility and less liquidity, at least to me, is not particularly attractive. Am I totally wrong here?

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Post by hlpsg » Mon Jul 12, 2004 8:37 pm

All
I made a serious mistake which makes all my questions irrelevant, I know I'll laugh my head off about this a year down the road, but you guys go ahead first. I misread the prices for the futures I was testing on. The prices were in ASCII format and came like "230.50" or "242.25". This means $2.30-1/2 per bushel and $2.42-1/4 respectively. In the software I wrote I took it to mean $230.50 and $242.25. You must be thinking I was mad to be able to make a profit considering all the premiums I had to absorb.

Well, I learnt something today, back to the drawing board!

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Post by ksberg » Mon Jul 12, 2004 9:20 pm

hlpsg wrote:I made a serious mistake which makes all my questions irrelevant, I know I'll laugh my head off about this a year down the road, but you guys go ahead first. I misread the prices for the futures I was testing on. The prices were in ASCII format and came like "230.50" or "242.25". This means $2.30-1/2 per bushel and $2.42-1/4 respectively. In the software I wrote I took it to mean $230.50 and $242.25. You must be thinking I was mad to be able to make a profit considering all the premiums I had to absorb.

Well, I learnt something today, back to the drawing board!
IMHO, that was definitely a missing piece of information. I don't think I'd recommend any beginning trader write their own trading software! There are just far too many ways to introduce errors. Instead, I heartily recommend picking up a reasonably priced trading platform (say MetaStock or WealthLab), and then code your systems. This will separate learning trading from building a trading platform.

There is ample opportunity to build something of your own once you have a reference platform, if that's your hearts' desire. Also, you will need this reference trading platform to check the accuracy of your own software.

The cost, hours and the errors of building your own platform will far outweigh the purchase of a commercial platform (even a very expensive one). I would consider the trading platform software purchase just the price of doing business in trading ... and data format/value questions will be taken care of by the software.

Cheers,

Kevin

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