PSYCHOLOGY OF TRADING COMMODITY FUTURES AND FOREX.

1. Do You Want to Fight?"
2. Technical Traders Should Still Examine Fundamentals
3. Commitments of Traders: What are the Big Boys Up To?
4. Using Contrary Opinion in Trading Markets
5. Entry & Exit Strategies
6. A Favorite Trading "Set-Up"
7. Trading Options on Futures
8. Determining Support & Resistance Levels on Charts
9. Spend "Quality Time" Studying Trading and Markets


1. Do You Want to Fight?"

"Fighting the Tape" (trend) in markets. Think about it: Do traders really want to fight the market? Remember, only the markets are ALWAYS right. No one else.
Traders many times think like consumer shoppers think: "I need to buy at bargain-basement prices to get the very best deal."Unfortunately, when trading futures markets (or stocks), thinking like a consumer shopper is unwise and unprofitable. I think one of the major mistakes most traders make is trying to "bargain hunt" and go long a market (or a stock) that he or she perceives as being "low-priced."
The same is true for trying to sell (go short) a market at perceived high prices. Crude oil is a good example here. All this year, the trading landscape has been littered with the carcasses of traders trying to pick a top in crude oil. These top-pickers have so far been brutalized by the market--which is always right.
Don't fight the tape. If the general market trend is one way, do not trade against it. In my "Top 10" trading rules list, rule No.1 is: Are the daily, weekly and monthly charts all in agreement on trend? If I'm thinking about position-trading a market and the aforementioned charts are not in agreement on trend, I'll likely pass on the trade. And I certainly won't initiate a position trade that is against the overall trends shown on the charts.
Some traders may prudently ask, "What about "contrary opinion" trading and the Commitments of Traders (COT) reports showing commercials buying in downtrends? Well, I cannot argue that contrary thinking and trading is valid and is employed successfully by some traders. I have used contrary thinking and trading, myself. But I think that type of trading method is an exception and not the rule, regarding becoming a successful trader. Also, commercial traders (the big boys in the business) most times seem to be on the right side of the market. However, we as individual traders do not have the resources (research staff, worldwide connections, very deep pockets, etc.) that the commercials enjoy.
Also, when good market trends get underway, even though trend traders don't "catch the bottom" (or the top), there is usually plenty of distance for the market to run to allow good profits to accrue.

2. Technical Traders Should Still Examine Fundamentals

I base the vast majority of my trading decisions on technical indicators and chart analysis--and also on market psychology. However, I do not ignore certain fundamentals that could impact the markets I'm trading. Neither should you.
In this feature I'd like to share with you the types of fundamentals in various markets about which technically oriented traders should be aware. While this article will be most beneficial to beginning and intermediate traders, the experienced traders may enjoy it as a "refresher."
I've told many times that I have been very fortunate in my career in the futures industry. In the beginning of my trading days, I was forced to learn about the fundamentals impacting all the markets I covered. (At one time or another, I covered every futures market traded in the U.S., and also many overseas futures markets.) I had to talk to traders and analysts every day, regarding the fundamentals that impacted the particular market on which I was reporting.
Realizing very few get that kind of unique opportunity to learn about market fundamentals, what can beginning to intermediate traders do to "get up to speed" regarding the fundamentals of the markets they wish to trade?
Here are some useful nuggets to consider regarding market fundamentals:
· You should know in what increments your market trades, the contract size, if it's physically deliverable, cash settled or both, and when first-notice day and last trading day occur. You don't have to become an expert on deliveries or notices, but you should be aware of the concepts. Reading about what the exchanges have to say about their markets is a great way to start out learning fundamentals.
· The Internet is indeed a wonderful tool to help you learn about futures market fundamentals--for free. Use your favorite search engine and do a search on your market of interest. However, make sure you use "futures" in the search words, as this will narrow the focus of the search engine.
· Here's a caveat on market fundamentals: The professional traders anticipate them and many times factor the fundamentals into price even before they occur. In fact, this happens quite often in futures markets. For example, it stands to reason that crude oil demand will increase in late fall and winter, and that crude oil futures prices should rise in that timeframe, as opposed to summertime prices. A novice trader may think it's a no-brainer to go long the December crude oil contract in September. However, keep in mind all the professional traders and commercial traders know this, and they have likely already factored this seasonal fundamental into the price of the December contract.
· There are U.S. government economic reports that sometimes have a significant impact on markets. Associations also release reports that impact futures markets. Even private analysts' estimates can move markets. Try to learn about the reports or estimates that have the potential to impact the market you wish to trade. You should make it a priority to know, in advance, the release of any scheduled report or forecast that has the potential to move your market. For example, if you are thinking about establishing a position in the FOREX market and the U.S. employment report is due out the next day, you may want to wait until the report is released before entering your position. The employment report can whipsaw the forex market in the minutes after it's released, which could stop you out of your position.
· If you trade commodities like cotton, coffee or cocoa, it's a little more difficult to find fundamental news sources for free.
You may want to subscribe to a news service like Bridge, where specialized reporters scour the world for news that impacts those markets. The U.S. Department of Agriculture has a website with reports on many commodities that trade in futures markets, including not only the major U.S. row crops, but also markets like coffee and orange juice.
Finally, traders should consider the knowledge of market fundamentals as just one more tool in their trading toolbox. The more tools in a trader's toolbox, the higher the odds he or she will be a successful trader.

3. Commitments of Traders: What are the Big Boys Up To?

Examining the Commitments of Traders (C.O.T.) report, issued by the Commodity Futures Trading Commission (CFTC).
The C.O.T. report is released bi-weekly--every other Friday afternoon. There is also a C.O.T. report issued on the following Mondays that includes futures and options data. However, this report is not as closely followed as the Friday afternoon report that covers only futures, because the combined futures and options report has less history.
The CFTC requires futures traders and hedgers who hold market positions larger than the CFTC's required reporting levels to report their positions on a daily basis. This is how the C.O.T. report is derived.
The C.O.T. report breaks down by open interest large trader positions into "Commercial" and "Non-Commercial" categories. Commercial traders are required to register for which futures are used as a hedge. The Non-Commercial category is comprised of large speculators--namely the commodity funds. The balance of open interest is qualified under the "Non-reportable" classification that includes both small commercial hedgers and small speculators.
What is most important for the individual trader to examine in the reports is the actual positions of the categories of traders--specifically the net position changes from the prior report. To derive the net trader position for each category, subtract the short contracts from the long contracts. A positive result indicates a net-long position (more longs than shorts). A negative result indicates a net-short position (more shorts than longs).
Now, if I've got many of you lost at this point, DON'T WORRY. I've got some suggestions later on that allow you to look at some examples of reports on other websites. What I'm trying to do at this point is familiarize you with the general basis of the report, related terminology and how traders use the C.O.T. report.
The most important aspect of the C.O.T. report for most traders is the change in net positions of the commercial hedgers. Why? Because studies show that commercials hold a superior record to other trading groups in forecasting significant market moves. The large commercials are generally believed to have the best fundamental supply and demand information on their markets, and thus position their trades accordingly. Along with the advantage of having the best fundamental supply and demand information on their markets, large commercials also trade large size, which in itself moves markets in their favor. It's important here to note that whether a particular trader group is net long or net short is not important to analyzing the C.O.T. report. For example, commercials in silver are the producers and they have never been net long, because they hedge their sales. In gold, however, the commercial mix is more heavily weighted toward fabricators who buy long contracts as a hedge against future inventory needs. So, again you need to look at the net change in positions from the previous report or several of the recent reports.
Individual traders that consider positioning themselves on the same side of the market as large commercials, when the large commercials become one-sided in their market view, is the best way to utilize the C.O.T. report.
Some traders do like to take the opposite sides of the trades on which the small trader in the C.O.T. reports are shown taking. This is because most small speculative traders of futures markets are usually under-capitalized and/or on the wrong side of the market.
Also, some traders will also follow the coat-tails of the large speculators, thinking the large specs must be good traders or they would not be in the large trader category.
Contrary to what some believe, divergences from seasonal open interest averages in C.O.T. report data are not reliable trading indicators. This is even true with agricultural markets, where one would suspect that hedging is a seasonal consideration.

4. Using Contrary Opinion in Trading Markets

One of the best methods to trade a market is to jump on board when prices "break out" of a congestion or "basing" area on the charts and begin a new trend. One of the most risky and least successful trading methods is trying to pick tops and bottoms in markets. Contrary opinion in the trading business is defined as going (trading) against the popular or most widely held opinions in the marketplace. This notion of "going against the grain" of popular market opinion is difficult to undertake, especially when there is a steady drumbeat of fundamental information that seems to corroborate the popular opinion.
To help you understand why contrarian thinking is used successfully by some traders, consider these questions: When is a market most bullish? When is a market most bearish? The answers are: A market is most bullish when the highest daily high on the chart is scored--it's downhill for prices from there. A market is most bearish when the lowest low is reached on the chart, and then the market turns up.
It's no wonder many novice traders lose their assets quickly in the futures trading arena. Traders are most bullish at market tops and most bearish at market bottoms!
Since nobody has discovered the Holy Grail of trading markets, the best traders can do is seek out clues, through chart and technical analysis, and possibly do some contrary thinking.
If you've read books on trading markets, most will tell you to have a trading plan and stick with it throughout the trade. A main reason for this trading tenet is to keep you from being swayed or influenced by the opinions of others while you are in the middle of a trade. Popular opinion is many times not the right opinion when it comes to market direction.
I'll give you an actual example of how contrarian thinking and trading can be successful. The year was 2002, the last big drought year in the Midwest that saw corn and soybean prices skyrocket. It was July that saw corn and bean prices trade sharply higher, based on ideas the hot and dry weather would continue in the Corn Belt. Then, after the close, the National Weather Service issued its 6-10 day forecast that, sure enough, called for more hot and dry weather for the Corn Belt. Bulls confidently headed home for the weekend. Even "local" traders on the Chicago Board of Trade floor went home long--something most never do, especially over a weekend.
Well, come Monday morning, the updated weather forecasts had changed a bit, but more importantly, trader psychology had changed immensely. The drought and resulting poor yields had all been factored into the market with prior price gains, culminating with Friday's big push higher. Corn and bean markets traded limit down on Monday and recorded very sharp losses for around three days in a row.
I know of one trader who used contrary opinion thinking and sold on SOYBEAN that Friday that prices were pushing higher. He made a good deal of money that next week. But isn't that top-picking? Yes, technically it is. Contrarian trading is not for everyone, but some traders are successful in employing it.


5. Entry & Exit Strategies

It is always questioned how to best determine entry and exit strategies when trading markets. Here are just a few of their quotes:
· "Though my success rate has been high, I am only breaking even financially, due to getting out too early in profit and letting my losses run too far."
· "Many articles are written showing when and where to enter trades... but how many articles are written about "running" positions? Where to exit surely has to be the biggest key to trading success!"
· "I would appreciate some advice or tips on how to and when to enter a market and when to exit."
Of course, if a trader knew exactly when to get into a market and when to get out, wouldn't trading be easy! But even the most successful traders in the world can't do that. The best they can strive for is to catch a bigger part of any move (trend) in the market, and then get out with a good profit before the market turns against them.
I've always emphasize trading with the trend and not against it, on the perils of trying to pick tops and bottoms, on support and resistance, and on letting profits run and cutting losses short, as well as trading the "breakouts." I won't repeat all those trading tenets here. In this article, I'll get more specific on entries and exits, and what to do if you are in a trade and are accumulating profits or absorbing losses.
First of all, if you are in a trade, you should already have a general plan of action in place, including potential entry and exit points, before you entered the trade. Certainly, you can alter your plan of action in the heat of battle, but you should not enter any trade without having a well-thought-out trading plan. Also in your trading plan you can have a few scenarios that could occur and what you would do if they did occur.
Entry and exits points in trades most times should be based on some type of support or resistance levels in a market. For example, in the metal markets at present, many traders think prices are close to a top. But I won't go short in a metal contract just because I think it's close to a top. I need to see some weakness in the market. I will wait for the contract to pull down through a support level and begin a fledgling down trend. Then, if I do go short, I'll set my buy stop just above a resistance level that's not too far above the market. And if the trend does not develop and the market turns back north, I'm stopped out for a loss that's not too painful.
Another way to enter a market that is trending (preferably just beginning to trend) is to wait for a minor pullback in an uptrend or an upside correction in a downtrend. Markets don't go straight up or straight down, and there are minor corrections in a trend that offer good entry points. The key is to try to determine if it is indeed just a correction and not the end of the trend.
On when to get out of a market when you're losing money, I have a simple, yet very effective answer: Upon entering the trade, if you place a sell stop below the market if you're long (buy stop if you're short), you know right away how much money you will lose in any given trade. You should never trade without employing stops. Thus, you should never be in a trade and have a losing position and not know where your exit point is going to be. I prefer setting tighter stops because I'm not rich and want to survive financially to trade another day. Yes, I'll get stopped out sometimes and then right away the market will turn in the direction I had planned. However, by setting tighter stops, I will not be in a position whereby I lose substantial money because I'm fighting the market, "hoping" it will soon turn in my favor.
What about when you've got a winner going and good profits already in place? This is the time to employ "trailing stops." For example, if you're long a market and it reaches your initial upside objective, but now you really think there may be more upside and you don't want to exit your trade. You put in a sell stop at a certain level below the market that allows you to stay in the winning trade. But if the market turns south you are stopped out and still have a decent profit.
I can't tell traders exactly at what percentage below the market (above the market if they are short) they should set stops or trailing stops, because all markets are different at different times, and traders have different views on how much money they can stand to lose. However, a general rule of thumb is to place stops and trailing stops just below a support level that's not too far below the market. (If you're short, place the buy stops not too far above the market.




6. A Favorite Trading "Set-Up"

"Without giving away any precious secrets, could you tell me a way to improve my entries and exits (on trades)? It seems nobody wants to share their system."
Well, first of all, I don't have any trading "secrets." What I do have is many years of market experience, including studying the markets and technical analysis--and listening carefully to the best and brightest traders share their philosophies on successful trading. (You should be suspicious if anyone tries to tell you they do have a "secret" to trading success, but that's another story.)
On better entering and exiting trades, first of all you need a trading plan--before you enter the trade--and you need to stick to it. Your trading plan can have different scenarios and options once you're into the trade, but the key here is don't "fly by the seat of your pants" when you're into a trade. You don't want to let emotions dictate your strategies while you're actively trading a market.
Know how much money you can stand to lose and then place a stop accordingly, and then don't change your mind when you're in the middle of the trade.
If you've got a winner going, you should also have a plan in place regarding when to take your profits. Again, your trading plan can allow for some flexibility once you are in the trade.
More specifically, I like to "buy into strength" and "sell into weakness." This trading method abides by the old trading adage, "The trend is your friend." Conversely, traders who try to "fight the tape" and be a bottom-picker or top-picker usually wind up getting their fingers burned.
One of my favorite trading "set-ups" is when prices have been in a trading range--between key support and resistance levels--for an extended period of time (the longer, the better). Then if the price "breaks out" of the range (above the key resistance or below the key support), I like to enter the market--long on an upside breakout or short on a downside breakout. A safer method would be to make sure there is follow-through strength or weakness the next trading session--in order to avoid a false breakout. The trade-off there is that you could be missing out on some of the price move by waiting an extra trading session.
If you are long the market, set your sell stop just below a technical support level that's within your tolerance for a drawdown. If you're short, set your buy stop just above a technical resistance level that's within your tolerance for a drawdown. Don't set your stops right at support or resistance levels, because there's a decent chance that those levels will check and possibly reverse the price move--and you'll miss getting stopped out.
If you've got a winner and decide to let your profits run (per your initial trading plan), use trailing stops that utilize technical support and resistance levels.

7. Trading Options on Futures

A while back, I was asked by the fellow traders if they should short the crude oil market because of its lofty price levels. I responded that I don't give specific trading recommendations, but I certainly do want to help my fellow traders succeed at the difficult task of trading futures markets. Given the sharp runup in crude at the time, and the rising volatility of the grain futures during that same timeframe, it was a good time to discuss trading options on futures--specifically buying puts and calls. You can also sell options, but your financial risk is not limited like it is when you buy an option. I won't get into selling options in this feature.
I know that many beginning (and even veteran) traders think options trading is too complicated, and they don't have a clue about the vega, theta, delta and gamma pricing formulas--or the strangles, straddles, butterflies and other such options trading methods. Well, don't worry. I'm not going to get into those complex strategies in this column.
Entire books have been written on options and options trading strategies, but I will only focus on basic low-risk and limited-risk trading strategies for beginning traders (and veterans, too). I'll also talk about using options to "hedge" winning trading positions in volatile markets. I do suggest that if you are interested in trading options, you should read a book or two on options trading. Again, you don't have to be a rocket scientist to employ simple options trading strategies.
First, I am going to assume readers know the definition of an option on a futures contract, and also the difference between a put option and a call option and "in the money" and "out of the money." Back to the big runup in crude oil recently. It certainly is tempting to want to short that market at present levels. However, remember that to successfully trade futures you not only have to be right on market direction, you also have to be correct on the timing of the market move. Furthermore, you can be right on market direction and very close to being right on timing the trade, but still lose your trading assets because of market volatility. In crude oil, for example, a trader could establish a short position two days before the top in the market is in, and still be stopped out and lose his trading assets because of the high volatility.
Purchasing options allows you to limit your financial risk and let's you ride out volatile market swings without the worry of increased margin calls.
Buying a put or call that is out-of-the money is a good, inexpensive way to wade into futures trading. The money the trader lays out to his broker for the option purchase is all the trader has to worry about losing. No margin money. No margin calls. He can sleep well at night. And he is still trading futures, learning the business, honing his trading skills.
Here's another trading tactic to think about regarding purchasing options in volatile markets. Just because you have a buy or sell stop in place, that does not guarantee you will get out of the market (filled) close to your stop. For example, weather markets in the grains and soybean complex futures often produce limit price moves--sometimes for two or more sessions in a row. If you have a straight trading position on in soybeans and the market moves against you by the limit, or multiple limits, your protective stop is virtually worthless. But if you had hedged your straight futures position with a cheap out-of-the-money option purchase, you have limited risk in a volatile market. Let's say you are long soybeans at $5.00 in a very volatile market. You may initiate that trade on the long side, but then purchase a $4.50 put option that limits your trading risk to 50 cents a bushel ($2,500 per contract). The trade-off here is that you are gaining peace of mind and losing some profit potential. But for many, that's well worth it. You can stay in the game to trade again another day, and not get wiped out by a limit price move.

8. Determining Support & Resistance Levels on Charts

In this educational feature, I'm going to tackle an issue about which several of my readers have inquired: How to determine support and resistance areas on the charts.
My favorite method (and I believe this the most accurate method) of determining support and resistance levels is to look at a bar chart and its past price history and then see at what price levels the highs, lows and closes seem to be touching the most. This method of determining support and resistance levels works on any bar chart timeframe--hourly, daily, weekly or monthly. Many times a bunch of highs or lows will be concentrated in a small price area, but not at one specific price. If that's the case, I will determine that area to be a support or resistance "zone." The one thing I will point out with determining support and resistance zones is that you don't want your zone to be so wide that it's virtually useless from a trading standpoint.
Major price tops and bottoms in markets are also major resistance and support levels. Unfilled price gaps on charts also qualify as very good support and resistance levels. Trendline support and resistance is also very useful to the trader. Projecting these trendlines to determine future support and resistance areas is extremely effective.
It's important to note that when a key support level or zone is penetrated on the downside, that level or zone will likely become key resistance. Likewise, a key resistance level or zone that is penetrated on the upside will then likely become a key support level or zone.
Another way to discover support or resistance areas is by looking at "retracements" of a significant price move--price moves that are counter to an existing price trend. These moves are also called "corrections." For example, let's say a market is in a solid uptrend. That uptrend began at the 100 price level and prices rallied to 200. But then prices backed off to 150, only to then turn around and continue to rally higher. This would be considered a 50% retracement of the move from 100 to 200. The 150 level proved to be solid support. In other words, the 50% retracement level proved to be a solid support level because prices dropped by 50% and then moved back higher. The same holds true for downtrends and "corrections" to the upside.
There are a few retracement percentages that work well at determining support and resistance levels. They are as follows: 33%, 50% and 67%. There are also two other numbers called Fibonacci numbers. (Fibonacci was a mathematician.) Those numbers are 38% and 62%. So, these five numbers are the best at determining retracement support and resistance levels. Most of the better trading software packages have these five percentages calculated in a tool, so that all you have to do, for example, is click your mouse at the beginning of the price trend and then at a high, and the percentage retracements are laid out right on a price chart.
Finally, support and resistance levels for markets can be determined by "psychological" price levels. These are usually round numbers that are very significant in a market. For example, in crude oil, a psychological price level would be $20 per barrel, or $25, or $30. In soybeans, a price of $5.00 or $6.00 or $4.00 would be a psychological level. In cotton, 50 cents would qualify. Silver would be $5.00.
There are other methods traders use to determine support and resistance levels, but those mentioned above are the most popular.

9. Spend "Quality Time" Studying Trading and Markets

Futures traders who consider themselves beginners and have traded for less than one year are very hungry for information they can digest in order to move "up the ramp" to an experienced (and hopefully successful) futures trader.
Most of these traders have "day jobs" or other commitments that don't allow them to be full-time traders. Thus, the time they do spend studying futures markets and trading needs to be "quality time."
I have been fortunate in my career, because I get to spend all day long at work studying and being involved with markets and trading strategies. And I love it! I feel a responsibility to my valued traders is to help you focus on the "quality" information you need to study--because the vast majority of you do not have all day long to be involved with the markets.
I began my career in the futures industry,Right away, I fell in love with the markets. After a few days on the job, I told myself: "I'm going to learn all I can about the markets, and then trade them--and we'll be rich!" Well, first of all I was pretty young at the time and was a bit optimistic (naïve??). Secondly, I soon found out that trying to become a successful futures trader is a lot like playing golf: When you first start out, you say, "Hey, this game is not so difficult, and I'm doing okay." But then after you have played the game for a while, you realize how challenging golf really is, and how "green" you really were when you started playing.)
So, what can beginning futures traders do to "ramp up" as quickly as possible, on the road to becoming a successful trader? Below are just a few "nuggets" that I believe will help the beginners get up to speed as soon as possible--and also may get some veteran traders who are struggling back on the right track.
· First of all, there is no substitute for real trading and market experience. You can paper trade for months, but when you've got real money on the line, it's different. Stuff just "sinks in" to your brain and is not forgotten when you're making or losing real money. But the good thing about experience is that it's something everyone can accrue. Just by reading this story, you are gaining some market-related experience, which is part of the experience you need to become a successful trader.
· Become familiar with the markets you plan to trade. Not only study the markets and their supply and demand fundamentals, but also study how the market is traded--on what exchange, the contract size, trading hours, expiration of the contract month, delivery notices, if applicable, etc. All of this information can be found free on the Internet. There is also other valuable information on the markets at those sites. Again, it's all free.
· Read some good books by successful futures traders. Not only do you need to know the markets, you also need to know how the successful traders trade them. Much of a trader's success comes from his or her "trading psychology." The best place to learn about trading psychology is from books, such as Jack Schwager's "Market Wizard" books. The better books also discuss money management in futures trading, which is also very important.
· Study a variety of trading methods--not just one trading system. I am asked a lot of questions from beginning traders asking about a certain trading system that costs X amount of dollars. My advice is to them is to take the money they would spend on a single trading system and go to a quality seminar and listen to several of the best traders in the world explain why they are successful.
· When studying, don't dive into just one subject or one market and focus solely on it. Spend your study time touching on several topics or markets. My experience is that I absorb more of the subject matter (and it's less boring) when I read some of it, and then come back to it later. Also, if you get into complicated subject matter, sometimes it's better absorbed when it's digested in smaller pieces.