August, 2006

Commodity Trading Myths

Risk Fright

From the very first time I mentioned the word “commodity” to another human I have been warned of the extreme dangers, the unlimited potential for loss and the foolishness of ever considering a venture into such a thing. These warnings were usually followed by a story about Uncle Harry and his Pork Belly Tragedy or some tale regarding an unknown friend of a friend whose first cousin dabbled in soybeans once and promised to never do it again.

It scared me at a time in my life when I thought I was fearless. Since then a lot of water has gone under the bridge and it seems to me now that it wasn’t the commodities that were scary, but the willingness of people to rush headlong into an investment without a clear understanding of the risk. Everything in life has a level of danger and safety lies in knowing what and where the danger is. The markets are no different. Commodity markets are dangerous not because they are more volatile than stocks, but because the leverage is so high.

I am not trying to down play the risk in commodities. There is always risk in investment but the astute investor will understand the need to follow a plan that includes diversification, limited exposure and pre-established risk parameters. This means trading in several different markets that are not closely related. In commodities there are 7 different groups to choose from. They are: metals, meats, grains, softs, interest rates, currencies and stock indexes. It also means keeping a close watch on the percentage of equity allowed for each trade and then it means carrying stops to get out if the market violates the plan.

One of the new services we are offering traders at Dillon Gage is a “clients only” web page where we put out trade ideas each day that will identify the market, the entry point and the method of entry. It will also give the trader a suggestion for how much the risk is estimated to be and as the trade progresses, where an objective could be established. If one of the trading ideas seems appealing, the client can make a quick phone call for a more complete explanation and order placement.