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Commodity Trading & Trend Following Mechanical Systems

InvestorEducation / Learn to Trade Jul 14, 2009 - 06:57 AM GMT

By: Andrew_Abraham

InvestorEducation

Best Financial Markets Analysis ArticleOne of the biggest differences in commodity trading is that many successful commodity trading advisors use trend following mechanical systems. Of course there are other commodity trading advisors that use pattern recognition …counter trend as well as basic fundamental analysis to base their decisions.


However in my opinion, when a commodity futures trader uses a mechanical trend following system they put themselves in a position to capture rare large moves. The success of commodity trading comes from capturing these rare large moves with proper risk management. This is the key to compound money over long periods of time.

Trend Following commodity trading advisors over the years have programmed their ideas into mechanical systems that detail trade potentials ( entry and exit) as well as position sizing. There is no real thinking. Trend Following commodity trading advisors are looking for price to move. They do not predict, rather react. The goal is to catch a new trend. Commodity trading advisors look to take pieces out of the trend. Only liars catch bottoms and tops. There is no holy grail in trend following unlike buy and hold ( pray). It all boils down to making yourself available for those rare large moves( not losing too much money when they are not occurring).

Virtually everything is pre thought out with an exact plan ( yes an exact plan with successful Commodity trading advisors). The markets trade are thought out. The amount of correlation between similar markets are planned. Risk per trade is planned. What constitutes an entry signal.. How to exit a trade with a profit as well as a loss. What is the total open trade equity that is acceptable. This is like a well trained army or football team. Everyone knows what to do. There is no gut thinking.. I will x number of contracts today because I think this or that.. With successful commodity trading advisors, what will make them buy is that there is a price move beyond a certain threshold that in their model possibly signifies a beginning of a potential trend. The successful commodity trader asks himself/herself.. how much is this going to cost me to see if this trade works.

Commodity trend followers know that any trade is 50/50. There is nothing about being right. It is very simply…the trade is going to work or not..If there is a trend..it is working.. Pretty simple and clear. The huge difference between successful commodity futures traders and others is in their trend following mechanical system there is not just focus on entering …but rather ..how many contracts can I put on for my predetermined risk tolerance.. (R).

Successful trend followers know it does not matter to be right..actually, most trades don’t work. Lets say the win/loss ratio can be 30% wins and 70% and the commodity trading advisor can be extremely successful Simple.. small losses..rare..large gains.. and position sizing ( when the trade works..if the commodity trading advisor has numerous contracts based on his/her risk model). Look at it this way..lets say the JY goes from 100 to 108 and you have 1 contract…you make x.. but for the same risk per trade you were able to put on 2 contracts for the same risk..you have made much more money. Forget about all the nonsense of snake oil advertisments like 80% winners. It is the surest way to be a loser.

There are key questions the trend following mechanical system needs to answer
1. Which markets to trade based on my equity
2. What signifies a buy or sell
3. How do exit with a profit or a loss
4. How many contracts do you put on..( risk per trade.. risk per sector..total open trade risk)

Of course there are other issues..More so don’t think for one minute this is easy.. Even when you have a trend following mechanical system or a commodity trading advisor you need the discipline and patience to follow the system/ commodity trading advisor for at least 4-5 years.. Otherwise really don’t start.. I have seen more people quit at the first sign of a draw down and run to another system or commodity trading advisor. More so.. keep it simple..but not simplier..

Andrew Abraham
www.myinvestorsplace.com

Andrew Abraham has been in the financial arena since 1990. He is a commodity trading ddvisor and co manager of a Commodity Pool. Since 1993 Andrew has been a proponent of quantitative mechanical trading programs. Andrew's major concern is not only total return on investment but rather the amount of risk that one would have to tolerate in order to achieve returns He focuses on developing quant models that encompass strict risk adherence and correlation. He has been a speaker at conferences as well as an author of numerous articles. Andrew has spent years researching ideas that have the potential to outperform indices as well as maintain fewer draw downs.

Visit Angus Jackson Partners (http://www.angusjacksonpartners.com) Contact: A.Abraham@AngusJackson.com (mailto:A.Abraham@AngusJackson.com)

© 2009 Copyright Andrew Abraham - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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