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Forex Currency Trading Systems – The Fibs Ain’t No Lie – A Systems Approach to Trading the Forex

admin — Wed, 30 Jun 2010 20:46:53 +0000

When it comes to trading the Forex having a trading system is the number one key to success. Making currency trades as “mechanical” as possible is the only way to sanely trade a market where the traders fear and greed are always in play.

This is where a trading system shines. Having a system that says when “A” happens you automatically execute trade “B.” This kind of system has a great effect at removing much of our emotional trading.

How The Systems Work

As you probably know, Forex trading is based on the relationship of one currency to another – called pairs. And these pairs are used to create a trade. For instance you believe that the Euro is due to rise against the Dollar – or said another way – you believe the Euro is strong and the US Dollar is weak. Based on this assumption you would expect to see the Euro rise in value over the dollar and if it did you would profit.

So the pair you would be trading is the EUR/USD pair where the first currency listed, in this case the Euro is called the base currency. The second, in this case the US Dollar, is called the counter or quote currency. Each pair is quoted with a single number that expresses the relationship between the pairs. So if a quote of 1.4525 were quoted that would mean that it would take 1.4525 Dollars to exchange for a single Euro.

The Fibs

Fibonacci, often called the fibs, are a method of gaining some measure of predictive pricing in the Forex markets. They are based on the famed number sequence developed by a mathematician named, you guessed it, Fibonacci. The sequence that he developed is a sum where each of the two preceding numbers are added to form the next in the sequence. So a sequence starting from the number 1 would look like 1,1,2,3,5,8…and so on.

The Forex is especially sensitive to the fibs. If you spend any time with your currency charts you will notice how prices turn at or near Fibonacci numbers.

Now of course then numbers are not as neat and clean as 1,1,2,3,5 etc. In the currencies they look more like. .236, .50, .382, .618, etc., Using this type of number sequence you will find that you can use the Fibs as a price point to enter or exit a trading position. They offer a seasoned trader a certain measure of predictive capability.

They can be used in you trading system as the response to other market signals so if you get a market signal that tells you to enter the market long the Euro, then your mechanical response would be to wait until the prices broke through the next Fibonacci resistance line and then enter your position. Waiting for this type of movement would help prove that the price was on the rise.

Of course this is assuming that you expect the price of the Euro to go up, and that is not the only way the market could move, but this is the beauty of the Forex, you can trade the market up or down. It lets you make money in both directions.

By: Nigel Banks

Learn Currency Trading – 5 Common Deadly Mistakes

admin — Mon, 28 Jun 2010 06:58:59 +0000

If you want to learn currency trading you need to get the right forex education and avoid the mistakes of the losing majority. The mistakes below are common ones but there easy to avoid and you must do so if you want to enjoy currency trading success.

1. Following a Vendor Blindly

One of the most common errors is to think someone else can give you success – they can’t.

Most systems sold are junk – but even if you do find a good one, how can you follow it with discipline if you don’t know how it works?

You cant to have discipline to follow a system you must have confidence in it so you need to take the time to develop your own trading system or have total confidence in someone else’s logic.

2. Trading News Stories

We have more news at our disposal than ever before and all those stories are very convincing – but that’s all they are stories. The news reflects the greed and fear of the crowd and they lose longer term – try and trade news stories and you are guaranteed to lose as well.

The best way for any novice to trade is to simply follow the reality of price action on a forex chart and trade it – your trading the truth not an opinion and that is the only way to win.

3. Day Trading

Simply the dumbest way to trade.

It doesn’t work as all short term volatility is random and you can’t get the odds in your favour.

Don’t believe me?

Try and find a forex day trader with a real ( not simulated ) track record that’s made real dollars over the long term. Let me know if you find one I have been searching for 25 years and still not found one!

Avoid day trading at all costs!

4. Trying to Predict Forex Prices

If you try and predict prices in advance you’re hoping or guessing and that won’t get you anywhere in life and certainly not forex trading.

You must not predict wait for momentum to confirm a turn and you can look up how to do this in our other articles – it is essential to confirm a price turn, rather than simply guess when it might come.

5. Markets are Scientific

It’s amazing how many people buy into this myth yet it’s obviously not true.

Why?

Because if prices did move to a scientific theory, there would be no market, as we would all know the price beforehand and there would be no market. The reason a market moves is because we all have different opinions of where the price may go.

The far out investment crowd love scientific theories and like to follow the works and methods of gurus such as:

Gann, Elliot and Fibonacci.

Well they made no money with their theories in forex trading and neither will you.

So if you want to learn currency trading correctly avoid the common mistakes enclosed and work and getting a simple forex trading system which will help you trade the odds, you can understand and can apply with discipline.

If you learn currency trading the correct way ( and 95% of traders don’t ), then you can enjoy currency trading success and create a life changing income – good luck!

By: Kelly Price

Commodities Insights – The US Government Provides Inside Information in the Commodity Markets

admin — Sun, 27 Jun 2010 04:43:10 +0000

The U.S. government publishes a weekly report called “Commitments of traders” or “COT” which provides a very unique view of the futures and options market from the inside looking out.

The Commodity Futures Trading Commission (”CFTC”) is the U.S. government agency responsible with policing and regulating trading on U.S. futures and options markets. The agency keeps track of all trading activity that takes place in these markets. The CFTC’s power and authority to oversee all trading activity gives it unique access to inside information in regards to the identities of market participants and their positions. This information in the hands of futures and options traders can be extremely powerful. Many people believe this information is heavily guarded and kept out of reach to individual traders, and in most countries that is indeed the case, but not in the U.S.

The CFTC is mandated to keep the marketplace fair for all participants, big and small, and to prevent price manipulation from taking place. To achieve this, the CFTC releases certain information to the public on a weekly basis. This information is contained in the Commitments of traders (”COT”) report. The COT contains a summary of all positions held by the largest market participants. Making this data public helps to provide market transparency and gives the public a certain ability to police the markets as well. In addition to that however, it also gives traders access to a powerful tool. It helps to level the playing field between large and small speculators, though that may not be the intended effect. Having access to weekly changes in positions held by large commercial producers, processors, and users of the world’s commodities provides the little traders with a wealth of information that can never be obtained through any price indicators!

The weekly COT data provides individual traders with inside information regarding changes in hedging activities by commercial producers as well as speculative activity by the world’s largest money managers and swap dealers. The CFTC releases all of this information to the public weekly via the Commitments of Traders (”COT”) report.

It still amazes me how few people actually know about this report. And of those who know about it, few really understand the information and know how to put it to use. I’ve spent the last fifteen years studying this data and building entire trading strategies around this information. Recently (2009) the CFTC has begun to improve the report and is now even breaking down positions further in an effort to provide greater clarity into the individual market participants.

I am thrilled that that the U.S. government provides this wonderful service (no other government in the free world provides such a service) and yet I am also still puzzled how few people know the report exists. If you are trading futures, an examination of this report is like turning on the lights in a dark room! The positions are all revealed. The report provides a detailed breakdown of all positions and discloses which market participants (by category) are holding the positions. Amazing!

In 2006 the CFTC began a pilot to provide greater clarity of the commercial category, which had begun to change due to new trading practices (pension funds and swap dealer activity). To address these changes the CFTC began releasing a supplemental report called “CIT” or commodity index trader report in twelve agricultural markets. The CIT report discloses the positions of commercial producers and commercial consumers on a weekly basis. These large commercial institutions utilize the futures market to hedge their cash exposure in the underlying physical markets. For example, an energy consumer (e.g. airliner) may use the futures markets as a form of insurance; to lock in the price they pay for their energy consumption in the future. This is called “hedging” and it reduces a business’s risk to future market fluctuations.

An airline which consumes jet fuel can use the futures market to lock in the price they pay for their fuel over the next five years. This hedges their exposure to the risk of sharply higher prices in the next five years. If an unforeseen event were to occur which causes fuel prices to sky-rocket, the company would not have to worry as they would have their price secured for a predetermined period (in this example five years). These commercial consumers and producers are widely considered to be the most knowledgeable group of traders in the futures markets.

The Trading Groups in the COT Report
The commercial entities typically know more about the true supply and demand than any other trading group. There are two other categories of traders in the markets and their positions are also disclosed in the COT report. These are Large trader (managed money) positions and small speculators. The large traders are usually funds, such as a hedge fund, which typically use price indicators such as trend following techniques combined with fundamental information. What is interesting here is that most of the fundamental information that gets reported to the government (such as crop reports) all comes from the commercial traders. Thus, that’s why the commercials are widely considered to be the most “knowledgeable” group in the markets.

That said however, there are some things that are unknown to all market participants. For example, no one can know for sure what the weather will do a year from now. In addition, while we can certainly track the geopolitical tensions, there is no way to know for certain what any person or group may be planning to do. Thus, no matter how much information a person has access to, there will always be a degree of uncertainty. Professional traders do everything possible to reduce the element of uncertainty, but it can never be eliminated entirely.

The COT report is the kind of information you’d be happy to receive once in a lifetime, yet few people are aware that the U.S. government actually publishes this information on a weekly basis.

This information has provided the public with a ‘heads up’ to massive movement in and out of various futures markets, including the U.S. stock market. Consider the Nasdaq stock index at the height of the internet bubble at the turn of the last century. When the Nasdaq was trading around 5000 (its all-time high at the time) the COT report showed the commercial traders were actually selling off all of their long positions in the futures market and in a little over a weeks’ time had accumulated a record size short position in Nasdaq futures!

This article is an excerpt from the free e-book Slipstream Wealth. Read the full chapter in the free e-book Slipstream Wealth downloadable at SlipStreamWealth.com

By: Floyd Upperman

Trading Stocks – How to Buy Safer Stocks?

admin — Wed, 16 Jun 2010 08:30:32 +0000

So you bought yourself a stock and it crashed losing 30 percent overnight. What do you do now? Good question, indeed. And it’s a tough one too, so there is really no right general answer. Your trading plan, which you should have prepared before you even started trading, should answer this.

But let’s ask an easier question and one that is related to the problem at hand. Namely, is it possible to tell how risky individual stocks are so that we could avoid situations like that in future. Certainly, not too many people enjoy waking up to a disaster like that.

In other words, we would like to know if there are some measures of risk for the stock market. Yes, there are and one such a measure is called the beta or the beta coefficent.

What this coefficient measures is the stock volatility. It measures it relative to a broader market, which has the beta of one. A stock whose beta is one is about as volatile as the general market. Stocks with their betas lower than one are less volatile and those with betas higher than one are more volatile than the general market. The beta is not constrained from the above, in principle, so there are stocks with betas as high as 3 or 4. And even higher. Many stocks like that are penny stocks, which is one reason why penny stocks should be avoided.

Now, the more volatile a stock is, the more risky it is to your portfolio. On the other hand, if you only swing trade or day trade, you want stocks like that as they move more rapidly and generate faster gains. Or losses, depending on your luck.

To be more precise, the beta measures the correlation with the broader market. For this reason, this coefficient can be even negative for stocks that are negatively correlated with the general market, meaning they rise when the market heads south or vice versa. This, for instance, is often true of gold stocks. And since beta is not constrained from the below either, some highly volatile gold stocks can have pretty negative betas.

If you want your portfolio to be immune to excessive volatility, you should look for stocks with betas of one or lower. There are plenty of those out there too. The stocks of companies that produce staples tend to have lower betas. For instance, Procter&Gamble can serve as a classic example. They make soap. And last time I checked, there was really nothing exciting about soap, which is why the stock of a company like that is unlikely to generate much volatility. Another example is provided by utility stocks. Just like soap, energy is needed by everyone and all the time, meaning the stocks of companies that deliver those have little tendency to be cyclical and hence less tendency to fluctuate wildly.

Now, how do we find betas? That’s another good question. One way to do this is to use a stock screener, such as the one you can find at Yahoo! Finance or similar larger finance related sites.

Remember, though, that there are really no risk free stocks. Just some are less risky than others.

By: Waldemar Puszkarz

Ready, Set, Start Online Trading

admin — Wed, 16 Jun 2010 06:46:14 +0000

With a few bucks to spare and hopes of making more, you decide to try online stock trading. So where do you begin? If you were about to start tennis or golf lessons, you would start at the pro shop to get the right equipment. That’s the same approach needed to begin online trading.

Ok, you have a computer what else? Just any computer and dial up internet connection won’t do for online trading. Toss out the dinosaur hardware that is more than three years old and buy a computer with top speed. The old 256 megabyte models make great paperweights. Anything less than 1 gigabyte is not even in the game. For frequent travelers or commuters, consider spending more for a laptop computer to get portability that is necessary to stay on top of day trading. Online trading demands quick access and a reliable computer. Think of your computer as your business part for online trading.

RAM is the all important amount of memory that is available for programs in use. You need to set any software programs not essential for trading so that they will not run automatically when the computer turns on. Serious online traders use more than one trading site plus research so they need both RAM and speed.

Whether using a desktop computer or laptop computer, buy a flat screen monitor with the highest resolution you can afford. Online trading for day traders requires staring at a computer screen for hours which is rough on the eyes. The larger monitor is more comfortable to view and only needs a hookup to work with your laptop.

Traders who want to have instant access for online trading need a broadband wireless access card for their laptop computers. Another option is to purchase a wireless card from a major provider like Verizon or T-Mobile for a monthly fee or in increments of minutes. These cards are only useful at specific locations so know before you go whether your wireless card will work when you need it.

Set up your computer with files that are easy to access. Think of electronic files the same as manila files in the desk drawer. The more specific the file name, the faster you can find the file. This is very important when searching for the trend report or chart that you need this minute to make a buy or sell decision.

Subscribe to three to five online stock market newsletters. Start with free online news sources until you decide which is more useful. Keep what is helpful and delete the rest. Give yourself limited time for scanning newsletter or you’ll waste valuable online trading time reading.

That’s the basics necessary for online trading. You have a better chance of winning the online trading game when you start with the right equipment for the challenge.

By: Mark Crisp

Trading Stocks -Never Forget About A Past Trade

admin — Wed, 16 Jun 2010 02:41:32 +0000

We all know that emotions control every decision that an investor makes in any type of money related vehicle. Whether is be the stock market, real estate, art work or antiques, emotions ultimately set the final price on both sides of the transaction. Some investors have greater control over their emotions while other investors are destroyed by their emotional reactions to certain events.

One common occurrence that I have seen many investors make, including myself, is placing a position in a stock at the wrong time. My last article detailed the importance of timing, while this article will concentrate on the importance of staying focused and emotionally stable when things don’t work out as expected. In the past, I would study a stock’s chart, the fundamentals, the general market health and everything else that I felt necessary before placing a large sum of cash behind my beliefs. When things went wrong and I was forced to sell for a small loss, I would drop the stock from my watch lists and remove it from my memory. This was one of the biggest mistakes that I was making during my earlier years of investing. The greatest investors study their mistakes and learn why they were wrong. If you don’t learn from your mistakes, you will continue to repeat them and never move to the next level.

I was usually correct with my analysis on the particular stock but many times I was too early with my entry point during a new up-trend. Months later, I would come across the same stock in my screens but it was now up 25%, 50% or more from my initial buy point and stop loss. I would be frustrated for selling my stock too soon and was getting tired of using rules and missing big winners that I sold for a loss. I knew money could be made in Wall Street by using the law of averages to my advantage and employing strong money management skills but I needed to employ the rules more consistently. I started to practice what I was taught by selling my losers quickly and allowing my stronger stocks to ride their trends. Over time, I was experiencing a few more losers than winners but my stake was growing because these losers were smaller in size than the winners. The words written in the books were true; Jesse Livermore, Gerald Loeb and William O’Neil were all accurate with their lessons about cutting losses quickly.

More importantly, I learned to keep strong stocks on my radar even if I bought too soon and was forced to sell for a loss. My timing was wrong and my ego was shot because I was wrong, so I typically decided to stay away from that specific stock because it had already taken my cash and my pride. Emotionally, I was burned by the stock even though this was not entirely true. Investing is a game of trial and error. It is okay to buy a stock at the wrong time and sell, only to buy it again because they timing may be better. If you cut the losses small and allow winners to grow, the averages will ALWAYS work out, I promise. You must be honest with yourself to allow the averages to work out. You cannot allow a stock to drop past your sell point and you must try to always hold the strongest stocks without selling them during a premature pullback. This all sounds so easy but it is not! If it was so easy, we would all be extremely rich and the stock market would be everyone’s full time job.

I kept using my system of trial and error and started to record every thought and transaction I made. With my revised philosophy in place; I continued to study the stocks that I was forced to sell and tried my best to re-purchase, even at higher prices than my original position if the time was right. Even now I have these issues, the greatest traders of all time always had these issues and every fund manager must decide if the time is right. My latest example, which can relate to almost everyone in the community is Paincare Holdings, a stock that was purchased solely as a “test buy” that I was forced to sell. If things turn around and the general market starts to rally, I would have no problem buying the stock at a higher price than my original position if the opportunity presents itself.

LaBarge is another example, first showing up on the screens at $9.35 but during a down-trending market. The new pivot point and buy area was $14, over 50% higher than the original price but a solid entry point regardless of past gains or prices. Mentally it is always the toughest to buy a stock at a higher price than you were watching it at an earlier date but it can be the most rewarding strategy. Never look at a chart and toss away a candidate because it has moved up 50% or even doubled in recent months, the real move may just be beginning.

The moral of this article is to make you understand that timing may be your only issue when buying stocks so never throw away a possible superstar because you bought too soon. Keep it on your watch list and be prepared to initiate another position, even if it will cost you an extra point or two. If you buy again and it doesn’t work out, re-peat the process, there is always a chance that the stock was not meant to be or your analysis was slightly faulty. In either case, learn what you are doing right and wrong so you can be prepared to use those lessons with the next stock.

By: Chris Perruna

Price Action Trading – Waiting For Confirmation

admin — Mon, 14 Jun 2010 17:19:34 +0000

Many aspiring Forex traders jump into the market before their entry signal has fully completed or fail to even develop a defined trading plan. It is crucial to a trader’s long-term success that they wait until all their pre-defined parameters are met before jumping into the market. In order to define a trading strategy you must define its entry and exit method. A highly effective and highly adaptable method is absolutely necessary to enable definition of entry and exit and allow for vivid confirmation of signals.

Once traders start jumping in and entering trades before the completion of their specific setup they are essentially negating their entire trading plan. The main point of developing a written out trading strategy is that it is done when you are in an objective state of mind set and are not reacting emotionally to the market. When a trader enters a trade that doesn’t fully meet his or her pre-defined criteria they are acting on emotion, these types of behaviors are what get most traders started down the slippery slope of emotional trading.

Employing an easily definable and effective trading method such as price action analysis will allow you to stay calm and wait patiently as your price setup forms and then strike with cat-like precision when the setup is complete.

The problem with many methods that traders use to trade Forex is that they have large gray areas, or entry and exit parameters that may change depending on what time frame you are looking at. The beauty of price action setups is that they show you exactly what price is doing and give you a unique perspective to analyze the Forex market on any time frame while still remaining relevant. For example, if a price action trader sees a possible pin/reversal bar form on a daily chart the signal will be noticeable on all lower time frames as well. It may be in the form of a 2 or multiple bar reversal on the 4 hour or a head and shoulders on the 1 hour.

The great thing about price action setups is that they generally confirm themselves across all time frames and leave very little to the trader’s discretion. Price action signals like any other are stronger on higher time frames and generally will be visually evident on lower time frames as well.

When you trade Forex using price action setups you can more readily attain the necessary objective mindset that is required to be consistently successful as a trader. Having a method that is easily definable and inherently reflects the very nature of the market is great tool for any trader. Waiting for a price action setup to confirm itself via subsequent price movement is the best way to be sure you are on the right side of the trade. Many traders rely on indicators which often cover up the underlying price movement and provide them with a false sense of clarity. Take the indicators off your charts and learn a few good price setups and you will see the Forex market from a whole new perspective. Patiently waiting for your pre-defined price action setup to confirm itself in the flow of price movement is paramount to any Forex trader’s long – term financial success.

By: Nial Fuller

Investing 101 – How to Profit Through Commodities Trading

admin — Sun, 13 Jun 2010 21:29:52 +0000

Investing 101: “Stagflation”-Wall Street’s flavor of the week-is a market environment comprised of anemic GDP growth and persistently high inflation, especially from food and energy. How does one invest in this climate? Not surprisingly, through commodities trading.

In the current market, certain sectors are cashing in on the record prices of oil futures by playing a role in the ever-intensifying quest for new oils sources. Similarly, anyone fully-invested in agriculture stocks is well-positioned to profit from soaring food prices.

Monsanto (MON), for example, is in the agricultural seeds business. This company is a ring-leader when it comes to finding innovative ways for farmers to increase their productivity. Grain demand is at an all time high, and MON is ahead of the game as it plans and cashes in on future agricultural needs.

Similarly, Syngenta (SYT) produces seeds and chemicals used by farmers to expand crop harvests. Both SYT and MON are seeing tremendous sales and earnings growth due to rising commodities prices and are great stocks to buy if you’re a commodities trader.

But food demand isn’t the only factor pushing these stocks’ prices higher. The race is on: Companies-and the nations that harbor them-are competing for the largest slice of the energy pie. Alternative energy stocks are hot investments as more investors see “green.” But what’s really driving up the prices of agriculture stocks is the brewing of biofuels, which places a strain on grain products.

It’s estimated that one third of U.S. corn crops are committed to ethanol production as a means to offset oil dependency. Ethanol is in huge demand all over the world, which means corn farmers have their work cut out for them. According to a report released by the U.S. Department of Agriculture, farmers use about 137 pounds of nitrogen fertilizer per acre. As these corn growers look to expand their acreage, they require exorbitant amounts of fertilizer- which they have to buy from somewhere!

Companies like Mosaic (MOS), Potash (POT) and Agrium (AGU) are experiencing unprecedented growth and margin expansion thanks to the demand for their fertilizer products. These three stocks are a great way to profit from rising food prices-and commodities trading in general.

It’s important to remember that the commodities bubble isn’t going to pop any time soon. The fact is, we’ve witnessed a major spike in worldwide demand for both food and energy. Even if people drive less and buy more fuel-efficient cars, crude oil supplies are waning. There’s no quick-fix solution to high oil prices. It doesn’t matter how much we’ve changed our behavior as of late-the changes haven’t been drastic enough to make a significant difference.

Another lesson in Investing 101: As long as demand continues to grow and supply, at best, flat lines, this type of market behavior will persist. The way to profit from this stagflationary environment is through commodities trading. There are no ifs, ands or buts about it.

By: Louis Navellier

Best Online Stock Trading

admin — Fri, 11 Jun 2010 01:25:04 +0000

When you go for best online stock trading then you should have a good knowledge about the stocks and the market. You have seen many people who earn a lot of money by investing in shares and stocks. They have a good knowledge about the current market situations and they know the right time when to invest in shares.

Life is full of ups and downs. There are people who have gone through a lot of hardships in life. It is not that people always get higher returns by investing in shares and stocks. You should be very careful in every step you take because one wrong decision can make you go bankrupt. So you should always go for best online stock trading.

When you wish to trade online, it is always better to consult someone who has a good knowledge of the market. There are stock brokers who can help you and also advise you in investing wisely. But you must be very careful when you chose your broker because there are many brokers who claim themselves to be an expert in the field but by the end you are bankrupt and you do not have any other way to get the money back.

Another important thing that you need to know when you go for best online stock trading is that you should be sure that the site you are visiting is a secured one. Nowadays there are lots of unsecured sites, which also provide you with the wrong information on stock trading companies. So, you should be very careful when you go for stocks and shares. There are people who think that investing in stocks help them in multiplying their money. But this concept is wrong. The main important thing is that you need to have a good knowledge of the stock market.

So, if you are really looking for some investments then you should consult a good broker or you can even consult your good friend who is a regular investor in a stock market.He or she can guide you in the right direction and you can get some idea about the market.

If you are looking to invest in online stock trading then you should go for websites that deal with stocks. Do not get mislead by the words of the people that you always get good returns by investing in stocks. Online trading has become very popular these days. It offers some sort of online service. You can choose your stocks online.

Internet stock trading has proved very useful for investors who can have all the latest updates on the market. So it has become very popular in today’s life. You can use the internet to invest online. So, make sure that you get all the knowledge of the stock market.

By: Amit Malhotra

Commodities Trading – Basic Risk Management – Hedging

admin — Wed, 09 Jun 2010 06:19:50 +0000

If you’re a commodities trader or are looking to become one, you know that two elements motivate you: speculation and hedging. Although speculation and hedging are not mutually exclusive and you can do both at the same time, speculation is primarily profit oriented. Hedging is more about protecting your profits or minimizing a potential loss and is therefore a defensive strategy.

When you hedge, you essentially recognize a hard fact; that is, traders cannot predict prices correctly all of the time. If you want to be on the right side of the trade, you need to not just to predict what direction prices are going to go in, but you also need good timing.

Although it’s important to guess correctly whether prices are going to move up or down, you also have to know when you should get in and when you should get out. You can improve your odds of doing so with some simple hedging strategies.

To begin with, let’s talk about a few elementary concepts. Hedging is effective, in part, because prices for commodities in the cash — i.e., spot — markets tend to move together, whether up or down.

In a “spot” or cash market, physical commodities are bought and sold. This differs from the futures market, where contracts are traded for future delivery of the particular commodity.

Even so, spot prices don’t move exactly together. The difference between the spot price and the current contract price is called the “basis.” The basis equals the cash price minus the futures price.

When they hedge, investors have two basic alternatives, either going short or going long. However, these two strategies are not used only to the exclusion of each other. They can be used together in a mixture, tailored to an investor’s needs. If you “go long,” that means you’re buying in order to sell later at a higher price. If you “go short,” that means that you’re going to sell before you buy, and expect that the particular commodity will have a future price decline.

In regard to going short, it might confuse you to think that you’re actually going to sell something you haven’t bought first and therefore don’t own. However, when you go short, you borrow the commodity or contract from the broker, sell it, and then buy the equivalent later to “balance the books.”

When you go long, you hedge based upon a weakening basis as the cash price falls in relation to the public futures contract. Going short gives you the advantage when the basis is increasing; that is, when the cash price rises relative to the futures contract price. It should be noted that a basis can rise or fall in opposition to price levels. What matters is the difference between the two.

To clarify, let’s look at the following:

Let’s say a heating oil seller wants to hedge 50% of the anticipated April production of three million gallons. The seller goes short by selling the April heating oil futures contracts at $1.98 per gallon on March 1. By the end of March, cash and futures prices both have fallen. This means that on April 1, when the seller delivers heating oil to the local terminal, the price has fallen to $1.85 per gallon. The seller then simultaneously hedges by purchasing April ethanol futures at $1.90 per gallon.

Because the standard heating oil contract covers 42,000 gallons, the speculator has to purchase 35.71 contracts at this scenario. However, partial contracts aren’t traded. The following figures are approximate, to make demonstrating this scenario easier:

Date Spot Market Futures Market Basis

Mar 1, $1.88 per gal. Sell in April at $1.98 per gal. -$0.10

Apr 1, $1.85 per gal. Buy in April at $1.90 per gal. -$0.05

The hedge result is as follows:

The gain on the futures trades is $.08 per gallon, with the sell in April at $1.98 per gallon, and the buy in April at $1.90 per gallon. $1.90 minus $1.98 equals $.08 per gallon.

The net sales price is $1.93 per gallon, or $1.85 plus $.08.

This results in 50% being hedged at $1.93 per gallon, with an April income of $2,895,000, or $1.93 per gallon times 1.5 million gallons. The remaining 50% is unhedged, at $1.85 per gallon; April income is $2,775,000, or $1.85 per gallon times 1.5 million gallons.

The average April sales price is $1.89 per gallon, for an April income of $5,670,000.

Without hedging, what would have been with the result? The seller would have received $5,550,000, or $1.85 per gallon times three million gallons. By hedging between the spot and futures markets, there was a net increase in April heating oil income of $120,000. Therefore, hedging cannot only help to protect traders from losses, but it can also increase profits.

By: Amar Mahallati