A Maniac Commodity Trader’s

Guide to Making a Fortune

A Not-So-Crazy Roadmap to Riches

by Kevin Kerr
Wiley © 2007
233 pages

Focus Take-Aways
Leadership & Mgt. • Trading commodities is exciting and stressful.
Strategy
Sales & Marketing • The commodities markets are going through a boom period.
Finance
Human Resources • It takes self-discipline to be a successful trader.
IT, Production & Logistics
• Keep a tight grip on your emotions and don’t be greedy.
Career Development
Small Business
• Traders fall into two groups: hedgers and speculators.
Economics & Politics
Industries • A good technical charting system can help you predict the future.
Intercultural Mgt.
Concepts & Trends • A technical system is only as good as the trader using it.

• Use reports and information specific to the commodities you trade.

• The underlying fundamentals of life can influence prices. For example, a

geopolitical problem in the Persian Gulf can affect the price of oil.

• Don't be afraid to trade.

Rating (10 is best)

Overall Applicability Innovation Style

6 5 4 7

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 Relevance

What You Will Learn

In this Abstract, you will learn: 1) Why the commodities markets are going through
a boom period; 2) Which are the most important commodities traded today; 3) How
to apply the fundamental do’s and don’ts of successful trading; and 4) How technical
analysis can help you map your moves.

Recommendation
If you are looking for a strong point of view that boosts the optimists’ side of commodities
trading, this is it. But Kevin Kerr’s assurance that you can make money by trading
commodities does not take into account the real risks involved, and could mislead potential
traders. The truth is that the odds are stacked strongly against any investor, particularly in
the now nearly-extinct open-outcry pit trading that Kerr discusses at length. However, his
rundown of the basic facts about the commodities markets will give you a start in learning
about this arcane investment science. getAbstract suggests that it may fit in as one among
many texts you might want to study before jumping into the pit.

Abstract

Commodity Markets
Commodity futures provide producers and traders with a method of smoothing out price
“Cycles in movements and a means of capitalizing on market moves. Commodity markets have their
commodities roots in ancient times when futures contracts were made primarily to actually receive or
can be very deliver the underlying commodity – for example, 200 sheep. Now, in only one out of 100
predictable. There
are no CEOs on trades does a delivery settle the contract.
the inside cooking
The world commodity markets are booming now. Demand from China, India and the
the books. There
are no accounting United States for raw materials is pushing markets up. Look out for vulnerable commodities
firms puffing up – those affected by global storm seasons. The hurricanes that hit the U.S. in 2005 created
profit reports.” enormous demand for building materials for reconstruction, sugar and natural gas. Sugar
is a key ingredient in the manufacture of ethanol, and the hurricanes badly affected the
sugar crops in Florida, as well as the supplies of natural gas, used in heating and cooling.
You can make money in commodities. It is not difficult to predict market cycles, and
in many ways commodity trading is less risky than stock market gambles. The most
important commodities traded now include:
• Gold – Gold and other precious metals have been registering record high after record
“The commodities
markets are
high. Gold is, of course, a hedge against inflation. It is also important in jewelry and,
always in flux, and thanks to electronic gold credits, it is re-emerging as a currency.
it’s important to • Silver – Silver recently recorded its highest closing price in more than two decades.
keep up with new
markets and new
An exchange-traded fund in silver has helped drive the market up.
opportunities.” • Heavy metals – Platinum and palladium are important as raw materials for various
electronic instruments. These markets are volatile and margins are steep, but they
offer great opportunities.
• Energy – Oil is the most important commodity in the energy markets, but electricity
and even solar power have potential. Coal prices have been rising, and coal may be
an important part of the solution to the oil crisis.
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 • Beef – Beef prices have been climbing with demand. Supplies are tight, but more
“Freemasons
countries are opening their markets to U.S. shipments. However, the market for cattle
would be may be too volatile and illiquid for beginners.
considered a • Tropicals – The commodities of coffee, sugar, cocoa, cotton and orange juice grow
fairly open society
compared with
mostly in the tropics and are also called the “softs.” Ethanol demand is helping push
floor traders... the price of sugar up, and demand is also rising for cocoa and coffee. These markets
The world of the are fast and volatile.
exchanges is
one unto itself.” • Soy – Beans, oil and meal are three distinct markets, each with its own fundamentals.
• Water – The world’s population is growing and demand for water is rising, especially
in China, but the supply of fresh, clean water is shrinking. The Dow Jones U.S. Water
Index lists 23 companies, most of them utilities.

“The difference Trading Secrets

between Floor traders have their own culture and language. Some of the fundamental do’s and
professional don’ts are:
traders and
everyone else is
their method and
• Do have a plan. Know what your goals are and what your strategy is. Know how
discipline – and much you are willing to lose on any trade before you place the trade. When your loss
this is the reason limit is reached, get out.
for their success.”
• Do take profits. Don’t leave money on the table. Don’t be greedy.
• Do use a “trailing stop” order that moves up with the market, but protects your
downside.
• Do cut losses and let profits run.
• Do take a broad view.
“One of the most
difficult and yet • Don’t be greedy – be disciplined.
vital skills of a • Do know what risks to take and which to avoid. Commodity traders make their
trader is being
able to decipher money by taking risks. However, they are careful to limit their risk. Never do
fundamental business with anyone you don’t trust. Check the credentials of brokerage firms or
factors and individuals with whom you may be trading. Sources of information include the
translate them into
real, workable and
National Futures Association, the Better Business Bureau, the Commodity Futures
actionable trading Trading Commission and the attorney general’s office in your state.
strategies.”
Commodities markets often move in similar patterns. Technical analysis is a way of
looking at these patterns and predicting which way the market will move next; it can help
traders time the market. Elliott Wave Theory outlines several types of market waves, or
price structures, and suggests that under certain circumstances these waves will form a
repeating pattern. Technical traders should be aware of Elliott Wave Theory and know
“Participants are
divided into two how to apply it in practice.
broad categories:
hedgers, who deal
in the underlying
Sources of Information
commodity…and Many sources offer information about the commodities markets, but use them
seek insurance carefully and selectively. Television market commentaries can be a harmful
against adverse distraction, and are particularly dangerous if they take your mind off your goals and
price fluctuations,
and speculators, strategies. However, be aware of economic reports specific to the commodities you
who seek to trade. Among the most important are:
profit from
price swings.” • Government reports and announcements – Available on employment, GDP, Federal
Reserve decisions and Energy Information Agency updates.

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 • Commitments of Traders (COT) – Published weekly by the Commodity Futures
Trading Commission and a window into market operations.
“If we can identify
these patterns • Volume/open interest – The liquidity of the market; that is, how many people are
and pinpoint trading and the volume of trades.
what preceded
them and what • Commercials’ positions – Address the activity of the end-users of the commodity.
immediately The commercial users are usually responsible for most of the open interest.
followed them,
we have a good
• Report on unemployment claims – An important guide to the health of the economy.
roadmap for • Interest rates – The price of money has a fundamental effect on the monetary supply,
the future.” lending, borrowing and investment.
• Cattle on feed reports – Particularly important for beef traders; they report how
many cattle are being prepared for slaughter.
• Crop progress reports – The condition of current crops.
• Orange juice crop reports – Information on the state of the orange groves.
“There’s nothing
wrong with
• Energy Information Agency reports – These provide information on how much
wanting to crude oil and refined products remain in inventories. Inventories move up or down
save money on in correlation with market moves.
commissions,
but sometimes
paying a little Hedgers and Speculators
more can mean Floor traders work in a noisy and chaotic environment, and rely on hand signals to
the difference
between making
communicate quickly and confidentially. Generally speaking, traders fall into two
money and groups: hedgers and speculators. Hedgers use futures contracts to protect themselves
losing your shirt.” against price moves in an underlying commodity that they need in the course of their
business. Speculators, also known as locals, trade to make money on price moves. You
can use several different order types for different purposes:
• Market order – Buy or sell at the current price. It’s the easiest order to execute, but
may be risky in illiquid markets.
“Developing
a style takes • Limit order – Buy or sell at a specified price. Limit orders allow you to get the trade
time, effort, and you want, provided the market moves to the price you want.
dedication, but • Stop order – Turns into a market order when the market gets down to the price of the
having a technical
analysis system order. Traders use these to protect themselves against steep losses.
that you can • Good till canceled – These are also known as open orders, and remain open until
rely on at your
fingertips is one
they are filled, canceled or the contract expires.
of the greatest • Spread – A combination of long and short positions, sometimes spread over different
tools you can time periods, commodities or exchanges.
put in your
trader’s toolbox.” • Options – The right to buy or sell an instrument at a particular price. Options allow
you to limit the downside risk without limiting the upside potential.
Is a discount broker worth the risk? As with everything, you get what you pay for. Discount
brokers may be cheap, but they may not be there when you need to make a move in a fast
market. The resulting losses might be considerably more expensive than the difference in
“Use the news commission for a full-service broker. The same is true of self-directed accounts.
and information
as a resource; pull In some cases, you can negotiate a more favorable commission rate from a full-service
out what you need
and leave the
broker. However, the higher rate may entitle you to services that are worth having. So,
rest behind.” be sure you know what you are getting for your money. Don’t expect brokers to be able
to negotiate margins; this is usually beyond their control. A good broker should have a
clean record, at least a decade of experience and be dedicated to your success.

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 Technical Matters
Technical analysis is the art of studying past price patterns and using them to predict
future market moves. Traders use various kinds of charts and charting techniques to
“Emotions, good study price moves. Among the most important are:
or bad, are of
little benefit to • Bar chart – Each bar illustrates the range over which prices move in any given time
the commodities
trader.” period, usually a day, week or month. The top of the bar shows the highest price in
the period and the bottom shows the lowest. A glance at the bar chart tells you the
high, the low and the close for the commodity in question.
• Candlestick chart – Invented in Japan in the mid-19th century by a rice trader,
candlestick charts have been developed and improved since then. The candlesticks are
bars that look hollow if the commodity closed above its open, dark if the commodity
closed below its open. Wicks and tails above or below illustrate the trading range.
• Point-and-figure – These focus on price movements, but ignore time. They use “X”
or “O” to indicate rising or falling prices, respectively.

Technical traders have their own jargon to describe various kinds of patterns, and a
variety of theories to explain what the patterns mean. Technical analysis may be most
useful as a guide to timing market moves. However, technical know-how is only part of
what a trader needs.
“Whether you
do it on the floor Fundamental analysis is used to forecast eceonomic conditions, and includes everything
or electronically, from interest rates to crop failures to natural disasters. The underlying fundamentals will
trading is trading.” affect commodity prices; for example, a geopolitical crisis in the Persian Gulf or a blight
in the Midwest may affect the price of oil or corn, respectively. An old saying about
speculation rings true: “Buy on the rumor, sell on the news.” Be careful not to have an
open position on the day that a major report about fundamentals is released. Recognize,
too, that fundamentals are often widely known and already priced into the market.

The traditional “open-outcry” market is giving way to electronic trading, but open-outcry
markets will always be necessary for at least some purposes. However, major exchanges
have been focusing more and more on electronic trading, which, unlike traditional pits,
is open 24 hours a day and can be traded anywhere in the world.

The futures markets are a great place to make money. However, trading successfully
requires an enormous amount of discipline, an ability to think independently, and an iron
grip on your emotions. The five most important trading rules are:
“Every journey
begins with that
1. Understand your market thoroughly.
first step; set aside 2. Know the various types of orders and how to use them.
any fears and
go for it.”
3. Don’t trade beyond your comfort level.
4. Trade with a plan and a strategy.
5. Check your emotions at the door.

About the Author

Kevin Kerr is editor of Resource Trader and co-editor of Outstanding Investments. He
is a correspondent for MarketWatch from Dow Jones, and a frequent contributor to
Barron’s and the Wall Street Journal.

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