How to Play the Cycles in Commodities

 | Nov 15, 2012 | 3:35 PM EST
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As illustrated by the four cycles in the table below, there are identifiable patterns in each season -- perhaps not on the exact same day, but within a given window of time. And with these commodities, Mother Nature is clearly involved. For example, it would be very challenging for farmers in the Northern Hemisphere to start planting crops in the dead of winter and expect them to survive or for driving to be unaffected by bad road conditions in the winter. In addition, children's school schedules will continue to make it more difficult to go away on vacations.

But recognizing that commodities' cycles exist can offer you an advantage in selecting a market to trade. By using seasonal patterns, traders can anticipate future price movement based on historical data instead of being overwhelmed by fundamentals that is often very contradictory.

Once you identify a potential seasonal pattern, you must then decide how to formulate a trade. Following these three basic steps should put you on the right track:

Recognizing opportunities: By analyzing commodity charts and monitoring seasonal patterns traders can identify when a market may be poised for a move. We do not always know the catalyst for a market to move but we will have identified a potential trade and will have prepared our strategy to take advantage of this opportunity. You can always use charts to identify setups; however, the one thing we strive for in trading is to have confidence in our edge. By incorporating seasonal patterns with high % recurrence rates, it could assist in identifying viable trading ideas.

Choosing the appropriate strategy: Once identifying the opportunity traders must have a suitable strategy to implement. One cannot have a one size fits all mentality. Being that commodities have so much leverage and can be extremely volatile it is a good idea to be conscious of alternative trading techniques other than just an outright long or short futures trade. By incorporating spreads, by using a combination of options and futures there are endless options with a combination of the two pun intended. Find a strategy that fits your risk tolerance and be just as concerned about the capital at risk as the potential profit potential.

Managing the trade: After selecting your trade and strategy, you must then have a plan on how you will manage this trade. Your plan should answer some of the following questions before you enter the trade. What is the expected duration of the trade? When does this seasonal pattern start and when does it end? What is my exit strategy if the trade goes in my favor or moves against me? Will this be an all-in/all-out trade or enter and exit by scaling your position? What is the maximum drawdown I can take before I throw in the towel?

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