TRADETHINK ARTICLES : A Diversified Trading Approach

FutureSource.com: Fast Break for Traders

September 14, 2007

Education Edition

Today's Featured Article

A Diversified Trading Approach

By Chris Morse

A Diversified Trading Approach
A successful trader will at times follow up to 30 markets or more on up to three different time frames. Why follow this many markets and time frames? A given market may only trend 30 percent of the time. This means that most of the time a market is not trending and is choppy. To compensate for the lack of time a market is in a trend a good trader will follow multiple markets which will give the trader much more of a chance of finding where the trends are. Different time frames allow the trader to benefit from the variation of how a trend will setup and follow through each time. Sometimes a trade will go up very fast and fall back even faster (good for short-term). Other times a nice trade will look like climbing a mountain on the way up and back down (good for long-term).

Markets

It is important for a trading system to be able to follow multiple markets since an individual market may present trading opportunities at any given time.  If a given market is only trending a third of the time or less it makes good sense to follow multiple markets.

There are many market sectors in the commodities markets. There are even more markets within each market sector. For instance, market sectors may include the Indices, Financials, Currencies, Fuels, Metals, Meats, Grains and Softs.

Within just the Grains sector there are three main markets; Corn, Wheat and Soybeans. Further in the Grains you have Oats and Rice. You even have different variations on certain grains or complexes. Soybeans have Soybeans, Soybean Meal and Soybean Oil. Wheat trades Winter Wheat and Spring Wheat.

If one was to just be following Corn right now and not Wheat at the same time they could have missed out on a great trend that is currently going on in Wheat right now.

Take a look at the chart below to see how the trading system is tracking Wheat.



Look at the most recent trade signals for Wheat. The blue arrow pointing up is the entry signal. The light blue/cyan arrow pointing down is the systems exit. Clearly Wheat has been trending quite well.

Now let us look at a Corn chart.

 

Look at the most recent trade signals for Corn. The red arrow pointing down is the short entry signal. The light blue/cyan arrow pointing up is the systems exit. In this case the Corn is very choppy.

As you can see the Wheat trade is trending up while the Corn trade is trending down and choppy. If you were following Wheat you would be a winner. Had you just been following Corn you might be a net loser. Had you been following Wheat and Corn at the same time you would be in a good position to be a net winner. This is why it is very important to follow multiple markets. The more markets you can follow the more diversification you have.

Multiple Sectors

For even more diversification you will want the ability to follow several market sectors. There are eight market sectors in the commodities markets; Grains, Currencies, Financials, Meats, Metals, Fuels, Softs and Indices.

Had you been following just the Grains this year you may be a profitable trader. If you were following the Grains in 2006 you may have lost money. On the other hand if you have been following the Metals this year and last then you should be profitable in the Metals. Had you been following the Metals and Grains simultaneously the past two years you should have been successful. As you apply more market sectors to your portfolio the possibility of catching the trending trades goes up exponentially.  This is where a good trading system comes in handy. This is by allowing you the ability to calculate trends across many market sectors.

Time Frames

Look at the picture below and see three popular trading strategies following an identical twenty market portfolio.


There were times when the short-term time frame performed best and there were times when the medium-term and long-term time frame did best in a given year. Most important is the “All Time Frames Combined” column. By combining and applying three different time frames to a portfolio you have a more consistent equity curve. As a great trader once said “The only free lunch on Wall St. is diversification”.

Trading System

It can be very difficult for a person to follow thirty or more markets every single day. A well diversified trend trader will typically use a trading system such as Trade Think to track the markets for them. A trading system can do numerous calculations on a multitude of markets in the blink of an eye. Best of all a trading system will work for you every day. The system will not get tired or sick. Maybe you want to play golf or spend time with your loved ones. This is where a good diversified trend following system will be your friend. A good trading system will be completely automated in generating its trading signals for you. A good system will work on a multitude of markets, market sectors and time frames. A good system takes the emotion out of trading.

Summary

What is the catch? This type of diversification comes with a pretty steep entry fee for some. It typically takes a minimum financial commitment of at least $30,000 to follow a single time frame on about 20 markets across seven market sectors. To follow a 20 market portfolio across three time frames it can involve a portfolio of a minimum of $100,000 or more.
I wish you the best of luck in diversifying your commodities portfolio.

Disclosure: Commodity Trading has large potential rewards, but also large potential risks. You must be aware of the risks and be willing to accept them in order to invest in the futures markets. Don't trade with money you can't afford to lose. This is neither a solicitation nor an offer to buy/sell commodity interests. Users of the software are solely responsible for the operation of the software and trade postings to this website are either only as examples of how the software works or the results of operation of the software after the market closes provided to licensees of the software only to help validate their operation of the software. Trade Think does not manage any money or provide trade or investment recommendations.
Notice: Returns are hypothetical. Hypothetical or simulated performance results have certain limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not actually been executed, the results may have under or over compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight, no representation is being made that any account will or is likely to achieve profits or losses similar to those shown.

TRADETHINK SHOWS YOU AUTOMATICALLY:

• when to enter the trade ... • where to enter the trade... • trend direction ... • when to exit the trade ... • where to exit the trade ...

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. INVESTMENTS IN FUTURES INVOLVES HIGH RISKS AND YOU CAN LOSE A LOT OF MONEY.

FUTURES TRADING HAS LARGE RISKS. YOU MUST BE AWARE OF THE RISKS AND BE WILLING TO ACCEPT THEM IN ORDER TO INVEST IN THE FUTURES MARKETS. DON'T TRADE WITH MONEY YOU CAN'T AFFORD TO LOSE. YOU SHOULD CAREFULLY CONSIDER WHETHER YOUR FINANCIAL CONDITION PERMITS YOU TO PARTICIPATE IN THE FUTURES INDUSTRY. IN SO DOING, YOU SHOULD BE AWARE THAT TRADING FUTURES AND OPTIONS ON FUTURES CAN QUICKLY LEAD TO LARGE LOSSES AS WELL AS GAINS. SUCH TRADING LOSSES CAN SHARPLY REDUCE THE VALUE OF YOUR ACCOUNT. THIS IS NEITHER A SOLICITATION NOR AN OFFER TO BUY OR SELL FUTURES INTERESTS.

USERS OF THE SOFTWARE ARE SOLELY RESPONSIBLE FOR THE OPERATION OF THE SOFTWARE. TRADE POSTINGS TO THIS WEBSITE ARE EITHER ONLY EXAMPLES OF HOW THE SOFTWARE WORKS OR THE RESULTS OF OPERATION OF THE SOFTWARE AFTER THE MARKET CLOSES. THIS IS PROVIDED TO LICENSEES OF THE SOFTWARE ONLY TO HELP VALIDATE THEIR OPERATION OF THE SOFTWARE. TRADE THINK DOES NOT MANAGE ANY MONEY OR PROVIDE TRADE OR INVESTMENT RECOMMENDATIONS. PROSPECTIVE TRADE THINK CUSTOMERS ARE ADVISED TO MAKE DECISIONS BASED UPON THEIR SPECIFIC CIRCUMSTANCES AND NOT MERELY ON THE INFORMATION CONTAINED ON THIS WEBSITE. THIS BRIEF RISK DISCLOSURE STATEMENT CANNOT DISCLOSE ALL THE RISKS AND OTHER FACTORS NECESSARY TO EVALUATE YOUR PARTICIPATION IN THE FUTURES INDUSTRY, WHICH SHOULD BE CONDUCTED INDEPENDENTLY BY YOU WITH THE EXPERTS OF YOUR CHOICE.

ALL TRADING INVOLVES HIGH RISK. THERE HAVE BEEN NO PROMISES, GUARANTEES OR WARRANTIES SUGGESTING THAT ANY TRADING BY TRADE THINK USERS WILL RESULT IN A PROFIT OR WILL NOT RESULT IN A LOSS.

ALL RETURNS PRESENTED ON THIS SITE ARE HYPOTHETICAL. HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS ACHIEVED BY ANY PARTICULAR TRADING PROGRAM.

ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS.

TRADE THINK AND ITS CURRENT EMPLOYEES HAVE HAD LITTLE OR NO RECENT EXPERIENCE IN TRADING ACTUAL ACCOUNTS FOR ITSELF OR FOR CUSTOMERS. BECAUSE THERE ARE NO ACTUAL TRADING RESULTS TO COMPARE TO THE HYPOTHETICAL PERFORMANCE RESULTS, CUSTOMERS SHOULD BE PARTICULARLY WARY OF PLACING UNDUE RELIANCE ON THESE HYPOTHETICAL PERFORMANCE RESULTS.