Why Investing In Commodities (Part I)

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Why a person will want to invest in the commodities markets? The logical answer is “for the money”. Commodities markets are known for the leverage they work with, so to the small investor it makes sense to think that if they open a small account they will easily transform it in a fortune. Consequently, they can quit their jobs thanks to the “magic” of the commodities markets. Unfortunately, this is far from the truth, and if you open an account with those expectations you have a high probability of been extremely disappointed in the short to medium term. You can read hundred of books about how the markets work, fundamental and technical analysis, risk management, go to seminars or subscribe to newsletters, etc. This will increase your knowledge, but it will not guarantee your success in this market if you had the wrong idea and expectations when you opened your account. Your success in the market does not depend on how much you know, but in how you use your knowledge. If you have wrong expectations about the returns you want to get, you will most likely make bad trades. I have read many articles that say that most people –individual and professional traders- loose money in this market. Remember that the commodity market is a zero sum game, which means that for every dollar you make, somebody else loose that dollar. In order for a small investor to increase its chances of making money in this or any other financial market, there are certain things they have to take into consideration before opening an account. 1) The Clients Responsibility When something goes bad, you usually hear things like “I did not know that could happen”, or “nobody explained me about the risks” or “I did not know he/she was taking that much risk over the portfolio or my account”. Since you have to be of legal age in order to sign the account forms, I don’t understand how those excuses can be acceptable. A person who opens a trading account in any investing market has a responsibility of knowing what is happening with his/her money. Even if you have your money on a Mutual Fund where there is a professional managing those funds for you, still you receive information from that Mutual Fund which you should read and understand. This is the first mistake people do regarding their investing. They don’t know where they are investing their money and they are trusting that someone else will take better care of that money than themselves. Having a financial advisor, commodity broker, stockbroker, etc. means that they will most likely make better trading decisions over that money than the client because that is our job. This does not mean that the client, the actual owner of the money, should not have at least an idea of where that money is being invested and what the risks are. In other words, the clients do have a responsibility of knowing and understanding the markets or products where his/her money is being invested. If you want to open a commodities account, you can go to the CFTC and NFA Web pages and get accurate information about this market. In addition, when a client opens an account, he/she will receive educational information about the market, information that the client should read. The advantage for the client to read this information is 1) It will give you an idea if commodity investing is really for you, and 2) It will help you understand that this market is not something that will make you rich overnight. This second point is extremely important because if you really understand it before opening the account, you have a higher probability of setting yourself for being part of the group of investors who do make money in this market. 2) Can you predict the Future? Investing is the business of predicting the future. Whether you buy low to sell high, or you sell high to buy low you are saying that you know (or think you know) what the future price of an asset will be and hence you are betting on that future movement in order to make money. Unless you have a crystal ball in front of you, nobody knows the future. As you can imagine, not knowing the future makes the business of investing more difficult to succeed. In the case of the commodity market it is even more difficult because you have less time to be wrong. For example, if you buy a stock and the price move against you, unless the company goes bankrupt, you can wait for years until the price goes back up again and you are able to sell it. That is why everybody in that market talks about investing in the “long term”, although nobody tells you how long is “long term”. On the other hand, in the commodity market when trading future contracts since you are usually investing in the front months because those are more liquid months, you don’t have the luxury of the time. At expiration, you either close out the position or you roll it over which is not always the best thing to do. Not having that much time can also work in your favor because it forces you to close your positions and realize a gain or a loss. As a client, this gives you the incredible advantage of knowing if your broker or advisor has the potential of making you money or not. Since you have to close every trade that you are advised to make, that works as a scored card of your advisor’s abilities in the market. It is safe to assume that if you open an account with a commodity broker with a reasonable amount of money (for example $10.000) and the first 4 or 5 trades you loose money, that probably means that is better to close that account and move somewhere else. I am not saying or implying that a broker cannot have 4, 5 or more loosing trades in a row. Everybody has draw downs, is part of the business; but in order for a client to have the potential of making money on this business it makes more sense when they open their account to use the first trades as a score card of the broker or firms potential. As I mentioned before, this is the business of predicting the future. I always tell my clients that since I don’t know what the future will be, there are better chances of being right over a price movement for the next 2 or 3 days than for the next 2 or 3 months. Based on the studies and analysis, when you make a trade or give a recommendation you are doing it because you think you are right and will make money. With few exceptions, the market will tell you in the very short term if you were right or wrong. This means that in the very first days of the trade you will be making or loosing money. If you are making money, you let it run until the market takes you out. If you are loosing money on the trade you wait until your stop loss order is hit. Loosing trades are part of the business, but what is important is to be able to keep yourself in the game. People who make money on the commodity market are not the ones who make a killing in one or two trades. Successful investors or traders are the ones who always have money on their accounts for the next trading day. In the next part of this article, I will talk about the risks involved in investing and what are some of the mistakes investors and advisors make that increase those risks. Jorge Malo Jorge Malo is the President of TeoFutures, an Introducing Broker who specializes in working with investors who want to participate in the commodity market with a minimum of $5,000. TeoFutures trades Futures contracts and Options over Futures on a non-discretionary basis for our clients. Mr. Malo has more than 15 years experience in the financial markets in the US and abroad, and is a member of the National Futures Association. Please visit our Web page at http://www.teofutures.com to learn more about the commodity market and our company, and to subscribe to my Free Weekly Financial Newsletter with important market information and analysis.