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F.A.Q. - Frequently Asked Questions

Table of Contents

  1. How do I get started?
  2. Where can I find more information?
  3. Why doesn't everyone make money?
  4. How much money does it take to trade commodities?
  5. What is the difference between commodities and stocks?
  6. What is the difference between futures and options?
  7. What is the difference between fundamental and technical analysis?

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1. How do I get started?

Everyone already IS a "commodity trader." The commodities markets have been around since the beginning of time. Since prehistoric times man has traded what he has for what he wants or needs. Food, clothing, shelter, etc. - all of life is a transaction. You give in order to get.  Unless you are self-sufficient, you trade or you die.

Zig Ziglar once said, "You can get anything you want out of life if you help enough other people get what they want." In the best cases, everyone wins. I get what I want, and you get what you want. Unfortunately, much of the time I'm only getting my 2nd or 3rd choice, and so are you. Like Mick Jagger of the Rolling Stones once sang, "You can't always get what you want."

MAKE MONEY! That's what everyone thinks is the reason why they are interested in the commodities markets. People who have traded a long time will tell you that's why you START trading, but it's not the reason why most people CONTINUE trading. More about that later.

Someone once said, "The harder you work, the luckier you get." Success in the commodities markets is not luck. You must treat it like a business. You must study, learn from the experts, and constantly test theories in real-time circumstances. Neither success nor failure is final, but losses can be catastrophic. You always want to be able to stay in the game and not be wiped out.

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2. Where can I find more information?

The most reliable sources of information are the listed commodity exchanges (see my page "Exchanges"). The 2 largest in the U.S. are the Chicago Board of Trade (CBT) and the Chicago Mercantile Exchange (CME), which combined account for about 70% of all commodity volume in the U.S. First of all, they have been around for many decades. They have highly educated staff members, including PhD's and floor traders, who have helped literally millions of traders around the world get started in the commodities markets. Many other traders have probably asked the same questions that you have, and the exchanges should have brochures with those answers. Second, since they are carefully regulated by various government agencies, they must be careful not to mislead or misrepresent. You will never find them promoting some "secret system" that supposedly can make you rich!

One problem for the exchanges is that they have literally hundreds of brochures, and it's hard for most traders to know which ones have the specific information they want. If you can, try to visit Chicago and see the Chicago Board Of Trade (CBOT) and Chicago Mercantile Exchange (CME) for yourself. You can have direct access to their information centers and get a lot of great material. Best of all, it's free!

There are also many books, trading courses, magazines, videos, seminars, etc. offered to traders. Some are better than others, but some are really dubious! Some that I know of have literally cost people huge sums of money. To avoid potential lawsuits, I will not name any names here. There is a LOT OF JUNK out there!

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3. Why doesn't everyone make money?

Some people have said that the commodities markets are a "zero sum game." For every winner there is a loser. If you make money, someone must have lost money. That is not necessarily true.

Let's suppose a wheat farmer's crop costs him $3.00 per bushel to raise (after calculating all his costs). His crop will be ready for harvest in July, and the CBT July contract is currently trading at $3.30 per bushel. Although it's only May, he can "hedge" his crop by forward selling it for future delivery in July. By selling now he locks in a theoretical profit.

The buyer does not have to be a company like Wonder Bread or the maker of "Wheaties." He may be a speculator like you or me. He may think the crop size will not be big enough in July to meet the worldwide demand, and prices will be higher. Suppose his prediction turns out to be correct, and by the time July comes wheat prices are $3.60 per bushel. He can then sell it to Wonder Bread, who makes it into bread and sells it to a supermarket. The supermarket then sells it to a consumer like you and me for perhaps $3.00 per loaf. In this scenario, everyone makes money. No one is a loser.

Here's another scenario. Let's suppose that although the wheat farmer's cost is still $3.00 per bushel, prices for July are only $2.80. He is afraid that prices might drop more, so he decides to take a small loss rather than risk a larger loss. You or I think this is a temporary dip in prices, so we buy his wheat. However, prices continue to drop (as the farmer feared), and the best we can get is $2.50 per bushel from Wonder bread. Unfortunately, the supermarket tells Wonder Bread that they can't buy all their bread because of a drop off in demand, and so Wonder Bread has to dump their excess bread at an outlet store at a loss. In this example, everyone loses money. There are no winners - even the IRS loses tax revenue!

It is estimated that only 3% of all commodity contracts traded are between an actual producer and an end-user. The rest are between speculators. It is also estimated that only 20% of commodity traders make money. One of the most important things to remember is that making money is not the result of trying to make profits, or even of trying to avoid losses. It is the result of doing the right things deliberately and consistently.

Richard Dennis, the legendary trader, once gave this excellent advice: "Never confuse your NET worth with your SELF worth."

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4. How much money does it take to trade commodities?

There is no short answer to this question. But here is a "working" answer. First of all, calculate the dollar value of a particular commodity contract. Secondly, calculate the average daily and weekly ranges of that commodity, and convert it to dollar terms. Then estimate the reasonable stop loss for a long or short position in that market. That is the minimum amount of money required to trade a single time in a single market. And to learn how to trade, you will need to make more than one single trade.

Commodities are traded in large, standardized, commercial sizes. For example, grains such as wheat and corn are traded as 5,000 bushels per contract. If corn is priced at $3.00 per bushel, the value of each contract is $15,000 ($3 x 5,000). For most people, if they consider buying $15,000 worth of some company's stock, they take a long hard look at the company. However, it seems that few people take a commodity position as seriously as a stock investment.

There are some popular trading courses that recommend a beginning trading account of $5,000. This may seem obvious, but it is not how much you start with, but what you do with it that is most important. Some traders have turned a few hundred dollars into hundreds of thousands, while others have turned hundreds of thousands into just a few dollars! There is an old saying that the way to make a small fortune in the markets is to start with a large fortune!

The Number One Rule for trading? Only Use Risk Capital! Only invest money that you can afford to lose. This is very important for your psychology. Some people have said, "I'm going to start with $10,000, but if my account drops down to $5,000 I'll stop trading." This may seem prudent, but the odds are very high that this person will be a loser. The inherent problem is that this person will be watching their money instead of the market. The market does not care how much you or I have or how much we are going to risk. I strongly believe that if you are only willing to risk $5,000, DO NOT put $10,000 into your trading account. Even an experienced, professional trader can have difficulty with the mental discipline required to keep his money separated into 2 piles.

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5. What is the difference between commodities and stocks?

A commodity is a standardized contract for future delivery of a specific product. Formerly only agricultural products were considered "commodities,"  but since 1972 financial products such as currencies, government debt instruments, and stock indices have been included. On the other hand, stocks are shares of ownership in a company. For instance, if a person thinks silver prices are headed higher, they buy a commodities contract (future or option) for future delivery, or they may buy stock in a silver mining company. Assuming silver prices do rise, the profits of these 2 different investments may be widely different. In fact, the silver mine may even lose money due to adverse business conditions, which would cause losses for the stockholders.

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6. What is the difference between futures and options?

A commodity FUTURE is the OBLIGATION to either receive or deliver the product (at a certain place, date and time in the future) that is specified in a contract listed with a registered commodity exchange. A commodity OPTION is the RIGHT (but not the obligation) to receive a long or short position, for a specific listed commodity futures contract, at a certain price, within a certain time limit. The OPTION BUYER has the right to decide whether or not to exercise (i.e., convert to a future's position) his long Call or long Put position. The OPTION SELLER does not have this right.

Options can be a great tool for traders if used properly. There is a lot of misinformation floating around about options. Some people oversimplify the subject, while others can make them seem very complicated with mathematical formulas, etc. We have some excellent booklets available that explain options and their uses.

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7. What is the difference between fundamental and technical analysis?

All investors and traders need to analyze information in order to make their investment decisions. FUNDAMENTAL analysis is concerned with looking at the economic and political forces of supply and demand. Information such as crop plantings, annual gold production, and money supply are examples of fundamental information. TECHNICAL analysis focuses primarily on looking for repeating price patterns for different markets. Since the introduction of the personal computer around 1982, and the relative availability and low cost of data, the typical investor can combine all types of analysis in creative new ways.

My favorite quote is from the legendary Bernard Baruch; "Show me the charts, and I'll tell you the news." As important as fundamental information can be, talk is cheap. Investors "vote" with their wallet, and those buying/selling patterns MUST show up in the charts.

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Links To Other F.A.Q. Sites - well worth checking out.

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Glossaries & Explanations of Futures & Options Trading

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