TRADETHINK ARTICLES : Trend Trading Commodities

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October 19, 2007

Education Edition

Today's Featured Article

Trend Trading Commodities

By Chris Morse

Why Winning Less is Often More Profitable

When evaluating trading strategies often times traders are mislead into believing that a higher percentage of wining trades is better than a lower percentage of winning trades. In fact the markets only trend about 30 to 35 percent of the time and that is it. Since the commodities markets trend only about 30 percent of the time it is reasonable to look for a trading system that at least wins that 30 percent of the time. The other 70 percent of the time most market conditions are choppy.

System X 80 Percent Winners

Whenever I see a trading system claiming to have up to an 80 percent rate of accuracy or winners I personally become quite skeptical. If system X claims to win almost 80 percent of the time it may not be a very profitable system. If you were to win 8 out of 10 trades (80 percent winners) and your average winning trade is $500 then you have a profit of 8 X $500 = $4000. If the average losing trade is $2,000 then you have a loss of 2 x $2000 = $4000. Now if I win $4000 on 8 trades and lose 4000 on the other 2 trades I breakeven, because $4000 - $4000 = $0. Do not forget about the commissions. Now system X is a loser.

System Y 40 Percent Winners

When I look at a system that says 40 percent of trades are winners I am more interested because that system is probably not curve-fitted. If you were to win 4 out of 10 trades (40 percent) and your average winning trade is $2000 then you have a profit of 4 X $2000 = $8000. If the average loser is $700 then you have a loss of 6 x $700 = $4200. Now if I win $8000 on 4 trades and lose $4200 total on the other 6 trades I should win, because $8000 (winners) - $4200 (losers) = $3800.

Clearly it can make more sense to trade a lower percentage wining system that has more profits than to trade a higher percentage winning system that may breakeven at best. It is unfortunate that some system developers try to look for a high percentage winning system to attract the public with potential false hopes. I illustrate this because of the Holy Grail that so many traders are looking for and only to find that the high winning percentage Grail does not exist.

Commodity Inflation

With commodity inflation present it makes good sense to look at trend trading commodities for diversification in ones investment portfolio. It is very important to have diversification amongst the many commodity sectors including; Grains, Metals, Fuels, Currencies, Bonds, Foods and Fiber products.

I like the Trade Think suite of commodity trading strategies approach to trend trading the commodities markets I prefer trading systems that are not curve fitted and that go for the larger trend moves. The commodities markets have had very big moves recently with the lower US Dollar and commodity inflation. Just think if you would have had an opportunity to enter Gold or Soybeans, Wheat or Crude oil a couple of months ago or several months ago.

Which Market to Trade

An important question to ask yourself is which market to trade? If you were just following certain types of markets or market sectors lately your trading account may have taken a hit. What though if you had a robust strategy that follows all commodity markets like Trend Simplicity That type of trend trading has generated many trade signals across all of the commodity sectors.

When you are diversifying into commodities it is important for your trading strategy to be capable of following many markets and market sectors in order for the trends to appear. If you were only to follow two or three markets sectors you would certainly miss out on many good trends in the other market sectors. It is futile to try and be successful in these markets unless you can focus on all market sectors for your next trade. It is important to take sometimes many small losing trades until the big trend arrives for a signal. By using a system that cuts losses and will ride winners it is possible to succeed 40 percent of the time and do better than a system with a higher winning percentage.

The Trend is Your Friend

It is not how often you trade. It is when you trade and the direction of the trend. I like to see a trend following system that only goes long when the trend is up. Just as important I like a system that will also generate short (sell) signals. This way you can trade the markets if they go up or down. A good trend following system does not try to buy on pullbacks. A good trading system has the disciple to buy strength and sell weakness.

Summary

As has been illustrated a system that wins less often can be better than a system that has a higher winning percentage. It is important following a system which allows you to track all market sectors and not just two or three sectors. Also, a good trend following system does not need to take a lot of trades. Brokers tend to make more money than the clients after commissions with very active trading systems. Remember the markets only trend about 30 percent of the time. Why be exposed to all the additional risk by trading all of the time. Remember the trend is your friend. You must be patent to wait for the good trades and be willing to take some losses along the way.



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 returns have certain limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since 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.

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

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