Commodity Market Forecasts How Do I Trade Them Part 1 – Decrease Risk and Increase Staying Power

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Producing a high probability trade forecast is not easy. Just as difficult is determining the best trading strategy and vehicles to capitalize on the forecast. Read on to learn some of my favorites trading strategies.

Let's say you've done your homework. You've identified a pivot point, a futures market direction and have planned a time frame for the move. The only thing missing is the price amplitude. In other words, how big or small will the price move be?

Typically, the magnitude of the move will always be the unknown. With TimeLine forecasts we will always have an idea of ​​the direction and time frame, but it is up to real world commodity market forces to decide how far the move will carry.

The way to handle price uncertainty is through time and price diversification. Since we do not know how far price will carry, we need to have a commodity trading vehicle that will respond to both a small move and a large one as well. If we choose to use commodity options, buying far out-of-the-money options is a bad bet for small price moves.

The move may take place while the option value goes now. In addition, to buy an expensive option with a close strike and lots of time can be a bad bet if the market moves immediately against us and sucks its premium away quickly.

To handle time improvement, we need to compromise by buying two different options with different expiration months. We would buy an expensive option with a close strike with lots of time and also a cheaper, farther away option with less time. (Notice we have price diversification here too)

The long-term option is to be held for the complete move. It will gain similar to a futures contract once it's in-the-money. The shorter-term commodity option is used as the trading vehicle to be liquid on the first sharp move in our favor. Getting a fast double or triple is a good goal for the shorter-term option.

An option spread (selling an option against the purchase) is another way to take in some premium to help pay for the option purchases. Also, "granting" to create a "free" option trade is another technique. These more complex option strategies are well covered in other lessons.

To get even more price diversification, we scale out on price. And we get our time diversification by scaling out in time too. No one knows exactly when and where a price move will end. Simply having two completely different commodity options and scaling out will result in both time and price diversification when we liquidate.

How do we handle profit taking for the longer-term option? One way is to grant another option against it or to sell a futures contract as a hedge when a short-term rally has peaked. This hedge is removed once the correction is over. Read a complete treatment of this technique under our free course lesson # 26 entitled, "The Thomas Swing Method."

Part Two of Three Parts – Next!

There is substantial risk of loss trading futures and options and may not be suitable for all types of investors. Only risk capital should be used.

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