Traders Helping Traders E-zine for the week 9-25-2006 - Test Drive Edition

Part One - Erich's Trades

Question:

I was just toying with the thoughts...what are the funds up to in soybeans? I noticed that they have slowly increased their short position in beans. Just for fun, I thought I would look at all the COT's, and with the exception of coffee, they are consistently net long. Why is that? Why are they suddenly taking a net short position in beans?

Answer:

[I'll defer this question to Tom as he has some great advice regarding the COT data.]

Thanks for the question ... been awhile since I had a opportunity to do my COT tirade ... just kidding ... sort of ... :)

First we need to get a handle on what and who we're looking at. The COT is the by product of a CFTC requirement that all traders taking positions above a certain size (it varies according to market) report their TOTAL positions to the CFTC on a regular basis. The penalty for not doing so is steep.

The report itself is divided into 3 parts: Commercial, Non Commercial and Non Reporting. The non reporting number is us little guys, Commercials and others with positions below reporting thresholds. This number is derived by deducting the reported positions of Commercials and Non Commercials with reportable positions from the total open interest number.

The commercial number is just that, commercial firms reporting positions. The Non Commercial number is everyone but commercials who hold positions above the threshold. This would include funds, institutions and individuals with large positions.

Commercials take positions for very different reasons than funds or you and I. There are 2 classifications of commercials: producers and users.

Producers are already LONG the cash market. They own, raise, grow, store or otherwise control the physical commodity. Since they are LONG the cash they use short positions in the futures market to hedge there physical holdings. The only way they get hurt is by falling prices - they get less for the product when it is time to sell the physical. You will almost never see these people LONG the futures. Why would they? They are LONG the cash, getting long the futures only expands there risk of lower or falling prices.

Users have just the opposite situation. They have a need to buy the commodity; they are SHORT the cash market. They are only hurt by rising or higher prices. They use the futures market to hedge their purchase requirements by being LONG futures to offset the risk of their SHORT cash positions.

You will rarely see these folks short futures ... again, because that only expands their risk which is already substantial because they MUST buy the commodity to make their product. Think Kellogg's buying corn to make Cornflakes or Rolex and Zales Jewellers who need Gold and Silver to make watch cases and bands. You can think of all kinds of examples.

The commercials do what they do for actuarial reasons; it is, effectively, an insurance policy for them. The net positions, long or short, of the commercials will fluctuate depending on prices, production, etc. IT IS NOT A CASE of the commercials sitting around deciding whether to be long or short as we do.

At times the Elevators, Co-op's, and the farmer will be in the futures with big short positions and users will be absent the market. At other times the users will be in there long to the teeth and the producers will be on the sidelines. Commercials tend to be very early in taking positions and hold them for long periods through thick and thin ... until their insurance policy has served its purpose.

Why do you think the short side has been expanding as to commercials ... are we not in the midst of or beginning harvest? When do we historically have lowest prices? Right before, during and just after harvest when we have tons of stocks. Lots of reasons for the producers, the short guys, to be in there right now, low urgency for the users to be playing as their risk is higher prices.

Funds are a different story. They do what they do for the same reasons we take positions ... acceptance of the price fluctuation risk from the producers and users in exchange for hoped for profits. However they do their thing much differently than we do it. They have huge amounts of money to play with. They trade with very little overhead. They are in and out in the blink of an eye since they can make out quite nicely on very small price changes. A penny move for us barely covers our overhead. With 3,000 contracts in play a penny is big money for them. You get the picture.

I firmly believe we cannot gain any edge from following the COT. The actions of commercials and funds are in the prices we see on the charts. It's in there already. Trying to gauge what and when they will do things is futile. The best defence against these behemoths is to track Resistance and Support closely, to roll stops at significant R&S points and to work with small stops affording us an opportunity to demand performance from the market - and when it doesn't materialize to be gone early in the recognition process.

These are absolutely the best tactics to contend with these guys and play the game in their shadow.

Tom

Got a question that needs answering like an itch you can't scratch? Send it along to me at Erich@tradershelpingtraders.net and I'll be happy to try and clear things up for you.
 

A Sampling of the Markets we're covering this week...

Softs Market Overview

It was a busy week in the Soft complex as we saw a couple of big moves and a couple more markets setting up for us this week. The big disappointment was Sugar, which fell like a rock on Friday. I was watching this market so carefully, but with this big decline we're pretty much out of the game for the short term. What bothers me most is that we had two (yes, two) decent chances to sell the market, but I kept holding out for more. Guess I won't be doing that again.

Cocoa also made a major move lower on Friday. In hindsight I should have sold cocoa off resistance with a limit order. Yes, it's easy to do after the fact, but you should note that cocoa is one of the few markets that will reverse almost exactly from where it left off. I don't know what I was thinking on Thursday. I knew a reversal was coming because of the RSI test, but selling a limit order totally escaped me.

On a brighter note Cotton is settling into important support. We could sell the market here on Monday but the mini-rounded top formation is likely to generate a bit of a bounce, so we'll wait for that. Coffee is setting up nicely after waiting for a week or so, and our OJ trade is still progressing nicely.

OJ

OJ made a very strong move lower to finish off last week and got us a lot of clearance to adjust our stops. We're trading very close to our first profit target off 167 and have nearly $1000 in accumulated profit as of Friday's close. As was our problem with the Peso, these big moves can be a management nightmare, especially when we have this much in profit!

There are essentially three options. The first option is to bring the stops in above the reactionary high at 173.75. This is the "right" stop placement for this trade. It allows the maximum flexibility for OJ to continue lower, and given the strong looking DMI and hooking RSI, it seems reasonable to assume that prices will continue lower. The only "glitch" in this scenario is the trendline support just below the market at 166 – 167, which is why we used this as our first profit target.

The second scenario is to use intraday resistance at either 168 or 169. The problem with this is that the intraday resistance is not as well defined as it could be, so it's essentially a "pick 'n hope" type of stop placement. The upside is that it does have some basis, especially the 169 line which is also closer to the 170 resistance on the daily, and it serves to protect nearly $900 in profit.

The last scenario is to jam the exit stops in just above the close at 168. This will protect maximum profit, assuming OJ doesn't open above here on Monday. The downside is that it almost guarantees getting stopped out on Monday with little hope of riding the market lower.

There are no right answers in this situation. You have to balance the "bird in the hand against the two in the bush".

CONTINUATION of Short November OJ from 174.90
Exit Order: 173.75 (or 169.25)
Approximate Risk Exposure: $0 per contract
Profit Target: 167.15
Approximate Potential Profit: $1162 per contract
RRR: n/a
Degree of Risk: Moderate

The rest of the Softs are covered in the Subscriber Edition.

FLAT Metal Complex

The rest of the Grains Markets are covered in the Subscriber Edition.

The charts in this publication are all made using Gecko's Track 'n Trade charting software. You can get a demo for free here.

This is only a small sample of the markets we cover!

For a detailed analysis of ALL of the markets, with explicit charts, entries, exits, stops, risk/reward ratio, potential profit, (and much more) please join us at http://www.supportandresistance.com/subscribe.html

If you have any questions at all about any of these chart lessons, please feel free to ask at the futures trading forum or click here to email us. You can also chat with Erich and Tom live every Wednesday evening at 9:30pm eastern in the HotComm webinar room. Click the link for details about the Support and Resistance Trading Webinars.

Erich's Updates for Tuesday - watch the blog:
To Follow

Tom's Updates for Tuesday - watch the blog:
To Follow

Erich's Updates for Wednesday - watch the blog:
To Follow

Tom's Updates for Wednesday - watch the blog:
To Follow

Erich's Updates for Thursday - watch the blog:
To Follow

Tom's Update for Thursday - watch the blog:
To Follow

Erich's Update for Friday - watch the blog:
To Follow.

Tom's Update for Friday - watch the blog:
To Follow.

For a detailed analysis of ALL of the markets, with explicit charts, entries, exits, stops, risk/reward ratio, potential profit, (and much more) please join us at http://www.supportandresistance.com/subscribe.html

Take care, and good trades to you for the coming week!

The charts in this publication are all made using Gecko's Track 'n Trade charting software. You can get a demo for free here.
 

The Scorecard

Summary for the Month of July 2006

* NOTE!!! Trading commodities is RISKY!!!! These figures are estimates in the interests of tracking the trades. Erich may or may not have a real money position in any market covered at any given time. This Score Card does NOT apply to Tom's Trades. This is neither a solicitation to trade nor a recommendation of any strategy. Always consult your broker or advisor before attempting any trade. Commodity trading involves substantial risk of loss. See full disclaimers at the bottom of this email.

Homework

Pick of the Letter

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