Trading Commodities - Technical Analysis - Expectancy

When you do fundamental analysis within commodities trading, you look at economic factors, including crop yields, weather predictions, new oil extraction technology or new mines opened, and the like. Basically, you look at all factors that affect supply and demand.

By contrast, technical analysis is done by charting mathematical manipulations on such variables as price, volume and the like. Rather than looking at concrete factors such as weather and crop yields, you are basically charting mathematical formulations. The most important component of future price protection is what actual market activity has been in the recent past.

As you might predict, each of these different types of analyses has its proponents and detractors. They comprise two schools of thought. Both schools agree that predictions are at best broad-based, with probable outcomes rather than certainties analyzed. In one sense, technical analysis has the edge with one variable, which is expectancy.

Expectancy is calculated by multiplying the probability of the win times the average win. Then, you subtract from that the probability of loss times the average loss.

Novice traders, too, can use this powerful trading tool. For example, suppose that you have profitable trades just 30% of the time, with the average trade profit being 10%. Your losses averaged 3% of the amount invested, or $10,000.

Therefore, your average profit equaled .10 times 10,000, which equaled $1000.

Your average loss equaled .03 times 10,000, which equaled $300.

Therefore, the formula looks like this, with the letter "E" representing "expectancy":

E = (0.30 x $1,000) - (0.70 x $300) = $300 - $210 = $90.

Therefore, even though you had more losses than you had gains, you still saw a net profit of $90 last year. Although not a large gain, it's still something, and not a loss.

Basically, what you want to do with expectancy is to keep abreast of your progress throughout the year, so that you come out ahead over the long term.

Even though novice traders often make the mistake of focusing on the number of profitable versus costly trades, what's most important is your net profits over time. Expectancy helps you calculate and keep this in mind.

Those who trade in stocks are always weighing whether it's better to trade long term or short term, and if you're a novice or nonprofessional day trader, you might even be looked down upon. However, if you trade in commodities, the opposite is true. Short-term positions are generally better than longer-term ones, even for those who are relatively inexperienced.

If you're a professional trader, you know that you have to accept losses now and then. For nonprofessional traders, this can be difficult. Oftentimes, nonprofessional traders stay "in" to0 long, because they hope things will turn around so that they can still get a profit or at least minimize their losses. And indeed, in many cases, this is exactly what happens with stocks. However, commodities are different. The opposite is generally true.

In short, the longer you stay locked into a position, the longer you tie your capital up when that capital could be making you a profit. If you play your trades right, you can even compensate for past losses. You also have to accept that despite best efforts, no one predict correctly 100% of the time.

You should also note that most commodities trades happen because traders buy and sell futures or options contracts. Therefore, you only have a limited amount of time, usually a year or often much less, to make a decision. As the contract expiration date gets closer, the more and more likely you are to lose rather than gain on the particular commodity you're holding.

If you like high risk, commodities trading might just be the thing for you. It's fast paced and volatile. If you do the research and use the many tools available, you're likely to come out ahead in the long run. And make sure that you use expectancy as one tool. Too many people overlook this very important tool, and it can help you become a winner.