Anyone who has been in the commodity markets for any length of time, has searched for the secret that will make them rich, fulfill their dreams or simply give them the answers they have been looking for.
While these searchers for this key to the financial kingdom, have looked at technicals, fundamentals, seasonals, system trading or even a CTA or broker, I want to tell you they are looking in the wrong places.
The “holy grail” they have been looking for has been right in front of their eyes this whole time. It has been recommended by many advisors for a long time, however most of the non-professional traders have ignored this sage advice in their trading strategies and will remain non-professionals if they continue to do so. What is this secret? It is simply the ability to manage their money. In our society, the ability to handle one’s finances is what separates the person who lives paycheck to paycheck from the person who retires early. In the world of commodity trading, if you don’t manage your money, the board will take it away from you. Conversely, with the incredible leverage offered in the commodity markets, a wise trader can have the keys to the financial kingdom.
As long as I have been in this business, I have noticed one common trait of the traders that consistently lose money, they over-trade their accounts. Simply, they will put the majority of their entire account at risk.
When they do this and they lose, the majority of their account balance is wiped out and they are forced to send in more money or suspend trading.
Here is a simple equation to use to manage your account. This money management formula is available for download on our Web site in Microsoft Excel. This formula will determine the amount of contracts to trade relative to the risk tolerance and the amount of risk involved in the trade.
Take your account equity, divided by the amount you will risk on the trade, multiplied by the risk percentage. I would recommend you risk 5 to 10 percent of your account equity if you are a conservative trader and more if you are a more aggressive trader. As an example, if your account equity is $15,000, your risk percentage is 10 percent and your stop loss on a particular trade is $800. The money management formula indicates you should trade two contracts. In order to trade more than 2 contracts, you will need to increase your account balance to $20,000 or decrease your stop loss amount.
In theory, the more your account equity grows, the more contracts you should trade. Conversely, the smaller your account equity, the fewer contracts you will trade.
I want to give you a real example of the power of this money management formula. I have an S & P trading system that I follow very closely. While this trading program has done a very good job of trading, the difference in using a money management system versus not using a system is unbelievable. In 2008, the system had 46 closed trades with 33 winners, 13 losing trades for a winning percentage of 72 percent.
If a trader started with an account balance of $100,000 on Jan. 1 and followed every trade recommendation exactly as the program indicated, the trader would have a nice profit of $133,400 and an account balance of $233,400 in 12 months of trading.
That sure beats any mutual fund return over the year!
This is assuming one only traded 1 contract per recommendation. However, if the trader implemented the money management formula, and assumed a 10 percent risk tolerance for trading the program, his account balance would be $316,995.
Remember, as the account equity grew, so would the amount of contracts traded based on the money management formula. One would have a nice profit of $216,995 and an account balance of $316,995 in 12 months of trading.
Remember, a sound money management system is the most important part of a trading program.
Corn closed the week $.07 1/4 higher. The weekly export sales report showed net sales of 588,700 metric tons were down 52 percent from the previous week and 46 percent from the prior four-week average.
Increases reported for unknown destinations (174,800 MT), Japan (116,100 MT, including 33,100 MT switched from unknown destinations), Mexico (115,500 MT), Cuba (100,600 MT), El Salvador (22,800 MT, including 20,400 MT switched from Guatemala), the Dominican Republic (19,500 MT), and Colombia (18,000 MT), were partially offset by decreases for Guatemala (25,900 MT).
Net sales of 22,400 MT for delivery in 2009/10 were for Mexico. Optional origin sales of 15,000 MT were for El Salvador. For the marketing year, the U.S. has now exported 1.493 billion bushels of corn compared to 2.225 bb last year.
To reach the USDA forecast, the U.S. needs to export 12.9 million bushels each week. Planting progress remains the driving force for price direction. The Eastern U.S. remains well behind normal with Illinois only 5 percent completed as of May 4 with Indiana only 5 percent seeded. Iowa is on pace at 60 percent planted with Minnesota 59 percent seeded.
Strategy and outlook – Producers should have over 90 percent of their 2008 crop sold and/or hedged. The other 10 percent should be sold on a 20- to 30-cent rally. Producers should have managed their risk by placing new crop hedges as December has reached the initial upside target of $4.25 to $4.50 range.
A combination of cash sales, hedges and put options are effective risk management tools. If the new crop December contract can rally appreciably, producers should look to raise protection levels by rolling the put options to a higher strike price.
Soybeans closed the week $.20 1/2 higher. The weekly export sales report showed net sales of 654,400 MT were down 22 percent from the previous week and 3 percent from the prior 4-week average.
Increases were primarily for China (197,900 MT), Egypt (123,600 MT), unknown destinations (107,200 MT), Mexico (105,100 MT), Turkey (36,000 MT), and Taiwan (30,000 MT). Net sales of 121,000 MT for 2009/10 delivery resulted as increases for unknown destinations (124,000 MT) were partially offset by decreases for Japan (3,000 MT).
This year’s export pace remains well above last year’s pace as the U.S. now has export commitments for 1.192 bb compared to 1.061 bb a year ago. The U.S. only needs to average 1.1 mb to reach the USDA’s forecast.
Strategy and outlook – Producers should have over 80 percent of their 2008 crop sold and/or hedged. The other 20 percent should be sold in 10 percent increments on 40- to 70-cent rallies. Hedgers should now be considering placing new crop hedges as November soybeans have reached the long held target of $9.50 to $10.25. A combination of cash sales, hedges and put options are all viable marketing strategies to reduce price risk.
If the new crop November contract can rally appreciably, producers should look to raise protection levels by rolling the put options to a higher strike price.
Brian Hoops is president and senior market analyst of Midwest Market Solutions Inc. Midwest Market Solutions is a full-service commodity brokerage and marketing advisory service, clearing through R.J. O’Brien.
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