COT TrendTrader™ is a method for trading commodity futures. As the name implies, the trend and commitments of traders are the basis for this trading method. The trades generally last weeks and months for profitable positions and just days for the losers. There's a money management component, which if followed, will reduce the risk to a point that makes this method suitable for IRA and other long term investment accounts. The objective is to "invest" in the trend, which means having an appropriate account size for the positions you take.
Invest in commodities?
I know, commodities are the riskiest asset class out there next to options. Traders lose more money to the markets every day than they can rightfully afford to, so why even consider "investing" IRA and long term investment accounts in the commodity futures markets? Two reasons...
1) Commodities offer less risk than stocks!!!
Let's say wheat is trading at $3 per bushel; there's 5000 bushels of wheat per contract traded on the Chicago Board of Trade and each penny movement in price is = $50. That means the actual value of that contract would be ($50 x 100) x 3 = $15,000. Now let me ask you, if you put up $15,000 to buy a contract of wheat, what's the probability of you losing all of your investment? What do you think the odds of losing 50% of your investment would be? I'll give you a hint... wheat has not traded under $2 for over 30 years. Not since the Russians entered the open markets of the West to feed their people has wheat traded below $2, or about $2.20 to be specific. Applying that same logic to other commodities you can establish support levels that will provide opportunities for the patient investor!
2) Commodities will always have some value
Due to their scarcity, commodities will always maintain some value where as stocks are only worth the companies assets, minus debts and other IOU's, plus the perceived premium investors are willing to pay for ownership. Investors certainly assigned too much premium to Enron and United Airlines and thousands of other companies that were overvalued at the market top in 2000. With an S&P 500 P/E over 40 today (January 2003) and a 25 year historical S&P 500 average P/E of 17, you can see many stocks are still WAY over valued. Going back to the question before, what are the odds of you losing 50% of your investment in GM or Microsoft or even the power house GE, again? If the S&P 500 P/E reverts back to it's 25 year average of 17, the answer is a 100% chance of you losing half of your investment, AGAIN!
Using wheat again as an example, wouldn't it be possible to earn low risk capital gains by buying wheat each time it traded in the bottom 10th percentile of its historical trading range and holding that position as long as it took to trade back to its 50th percentile? It certainly would if each contract were properly backed with sufficient capital and the contracts were rolled prior to expiration. If this strategy were used with multiple commodity markets to diversify the long periods of draw-downs, could you see how this would be less risky than buying stocks or trading in and out of commodities?
Use Commitments of Traders data to identify market turning points!
COT TrendTrader™ takes this concept of buying at extreme lows and selling at extreme tops one step further by adding commitments of traders information to make smart investment decisions. Each of the 3 groups classified by the CFTC, commercials, large traders and small speculators tend to repeat their behavior over and over again. (more on CFTC trader groups) By subtracting each groups short positions from its long positions to get the "net-positions" for the group, you can literally see what group is in control of each commodity. Using net-traders positions as a basis for investment decisions, in my opinion, is the easiest, safest, most profitable way to invest in commodities. It's almost unbelievable that the government gives us such vital information that allows us to literally see what's happing "inside the market". No other financial market offers such information on its market participants.
Free COT charts offers this vital information in ASCII & Excel downloadable files which allows you to track the commitments of traders with your trading software or spreadsheet application.
The COT TrendTrader™ method is available to all COT Update subscribers!