Commodity trading: Some guidelines

You can be free. You can live and work anywhere in the world, be independent from the routine and not answer anybody. That's what commodity trading is. A stock broker became a full time trader, closed his business and moved to some peaceful place. I wish all traders could succeed, but it is not that simple. To succeed in trading, you need several innate traits without which you shouldn't even start. They include discipline, risk tolerance and facility with numbers.

In addition to discipline, risk tolerance, and ease with numbers, successful trading requires 3M's - Mind, Method and Money.

Mind means developing psychological rules that will keep you calm amidst the noise of the market. Mind is trading psychology. Method is a system of analyzing prices and developing a decision making tree. Money refers to money management, which means risking only a small part of your trading capital on any trade, like submarine. Do you know a submarine is divided into many compartments so that it won't sink if one section becomes flooded? Yes, a trader has to structure their account this way. So ‘Stop Loss' is necessary.

Traders make money on price swings or fluctuation. The idea is to buy when our reading of the market tells us prices are rising and sell when the uptrend runs out or steam. Alternatively, we can bet on decline and sell short when our analysis points to a downtrend, covering when the downtrend starts bottoming out. The concept is simple but implementing it is difficult.

In Nepal, almost every exchange is trading in future contract. Commodity futures look dangerous at first - 8 out of 10 traders go bust in their first year. As you look closer, it becomes clear that the danger is not in the "Future commodity contracts" but in the people itself who trade them. Futures offer traders some of the best profit opportunities, but the dangers are commensurate with rewards. Futures make it easy for gamblers to shoot themselves in the foot or higher. A trader with good money management skills needn't fear futures.

It is hard to become a good analyst but harder to become a good trader. Beginners often assume they can make money because they are smart, computer literate and have a record of success in business. You can get a fast computer and even buy a back tested system from a vendor with high speed internet but putting money or it is like trying to sit on a three-legged stool with two legs missing. The two other factors are psychology and money management. Balancing your mind is just as important as analyzing markets. Your personality influences your perceptions, making it a key aspect of your success or failure. Managing money in your trading account is essential for surviving the inevitable drawdown and prospering in the long run. Psychology, market analysis and money management - you have to master all three to become a success.

Derivative is a financial contract between two parties whose price is based on underlying price of particular products. Buying a stock makes you a part owner of a company. When you buy a future contract you don't own anything but enter into a binding contract for a future purchase of products.

The money you pay for a stock goes to the seller but in futures your margin money stays with the exchange as a security ensuring trader will settle their position when contract comes due. They used to call margin money honest money. Most people, once they understand how future works, are flooded with speed. An amateur with Rs. 75,000 can trade 40 lots a day. If his analysis is correct, let's suppose he'll analyze ($20 up in a day) lots of money. Let's suppose Rs.60000 a day, in this way within a few times, he will be a millionaire before the end of a year! Such dreams of easy money ruin gamblers. What if anything they overlook?

The trouble with markets is that they don't move on straight lines. Charts are full of breakouts, reversals etc. after the trader predicted $20 rise at the end of day but it is perfectly capable of dipping by 120.

In Nepal, many people are gamblers rather than traders. A gambler dreams of fat profit margin to the hilt and gets kicked out at first wiggle that goes against them. Their long term analysis may be right and gold may rise to its target price but the beginner is doomed because he commits too much of his equity and has very thin reserves. Futures do not kill traders but poor money management kills traders.

Futures can be very attractive for those who have strong money management skills. They are promising high rate of returns but demand ice-cold discipline. So, psychology and money management skills are two important factors which affect trading. An investor of commodity market does not have authority to blame the broker, clearing members and exchange only because of incurring loss. They must know the market and must do disciplined trading rather than gambling. Trading is a journey of self-discovery. If you enjoy learning, if you are not scared of certain risk, if the rewards appeal to you, if you are prepared to put in the work, you have a great project ahead of you. You will
work hard and enjoy the discoveries you'll make along the way.

Ravi Singh
Chief Operating Officer, NDEX

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