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As I stated in last month’s newsletter, I will focus each month on a different commodity, with the intention of bridging the gap for those new traders wishing to make the transition to trading commodities rather than stocks. The reason for this will become very apparent as we see the types of trends that commodities have been making over the last 12 months, while the equity markets, at least in Australia, have been largely range-bound. Remember, the best trades are found in strongly trending markets.
The subject of this article is how to stay with the trend. In the commodity markets the best tool for this is often the 2-day swing chart. There is a distinction to make here though; I am not saying that the best way to trade commodities is to take 2-day ABC trades. Rather, by using a 2-day swing chart as a trend indicator, it is possible to hold on for the bulk of a move with the trend. David Bowden worked out that in order to make the sort of money he expected to make from trading, he needed to get around 50% of each major move. A 2-day swing chart can frequently achieve far better results than this.
The market we will use to illustrate this is Sugar. The code for the continuous chart in ProfitSource is SB-Spotv, and contains the price data back to 1961. Sugar is another of what are broadly called the ‘soft commodities.’ It trades on the old New York Board of Trade (NYBOT), which is now part of the Inter-Continental Exchange (ICE). It is worth taking a look at the Exchange website to get the Contract Specifications. Click here to view Contract Specifications.
We find there that the contract is called ‘Sugar No. 11’. I don’t know what happened to 1 to 10, but at the time Gann wrote How to Make Profits in Commodities in 1941 they were up to 4 and 5! Sugar futures began trading on 16 December 1914. It is priced in cents per pound, and the smallest trading increment is 1/100 of a cent. This means that when Sugar is trading at 28.91, as it is currently, it is 28 cents and 91/100 of a cent. 1 contract contains 112,000 pounds, so the current value of 1 contract is 28.91c x 112,000 = $32,379.20. But you don’t need this much capital to buy 1 contract – all you need to outlay is the margin, which is currently $3,780.00. (Remember that all these prices are US dollars). Click here to view prices (PDF).
Sugar has 4 yearly contracts, which are March, May, July and October. The current codes for these for 2011 in ProfitSource would be SB-2011.H/K/N/V. Again, you won’t trade in any contract in the delivery month, so although it is still March, you would currently be trading in the May 2011 contract. The Spotv continuous chart, of course, takes its bars from the highest volume contract at any one time. You can see where it rolled over from March to May in Chart 1 below by the gap. This is not a gap that you could trade; it is just that the prices in the May contract were somewhat lower than the March contract.
Chart 1 – Gap Due to Contract Roll-Over
click chart to enlarge
Now that you’ve got your head around the contract specifications, let’s have a look at how you could use a 2-day swing chart to follow the trend of this market. Chart 2 – 2-Day Swing Chart 2009
click chart to enlarge
Starting in the middle of 2009, the 2-day swing chart made a series of higher bottoms before entering a sideways period of consolidation in the middle of August. There was no clear trend at this time, and if you were following the 2-day swing chart, you could have avoided trading this market for a 3-month period.
In mid-December prices broke out of the sideways range, finally taking out the 30 September high on the 15th. From here the 2-day chart made higher tops and bottoms all the way to the top on 1 February 2010. This was a major bull market top, and without too much trouble you could have picked it. But that’s a topic for another discussion. The point really is that you are combining the 2-day swing chart with all your other techniques. Chart 3 – 2010 – Bull and Bear
click chart to enlarge
2010 was the year of the 2-day swing chart in Sugar. From the bull market top on 1 February to the bear market low on 7 May, the 2-day chart made lower tops and bottoms all the way. If you compare this chart with Chart 2 you can see that the first breaking of a 2-day swing bottom after the February top was the sign of a change in trend. After that it was short trades all the way.
After the low on 7 May, there was again a lower 2-day swing top, but then the market made the first higher 2-day swing bottom on the 17th. On the 19th the previous swing top was broken, turning the trend up. At this point you could have started looking for long trades, and the 2-day chart continued to make higher tops and bottoms all the way to the 11 November top, which was actually a bigger bull market than the bear market in the first part of the year. Notice the 3 dates on the chart – 1 February, 7 May and 11 November – and how close they all are to Seasonal dates.
Just to put things in context, the bear market range from February to May was 30.40 – 13.00 = 17.40. The bull market range from May to November was 33.39 – 13.00 = 20.39. A 1 cent move (1.00) in Sugar is worth US$1,120.00, making these two runs worth $19,488.00 and $22,836.80 per contract respectively. If you could get just 50% of these runs, would you be happy?
Once again I will emphasise that I’m not saying that you could just go short in February on the breaking of the 2-day swing low, reverse positions in May on the breaking of a swing top, and then buy a villa in the south of France! You use all your techniques in combination. But for an exercise, look at 1-day and 2-day ABC trades over this period and see if the 2-day swing chart would have helped you as a main trend indicator.
Now, is all this just a pretty historical exercise, or can we use the same strategy in 2011? From Chart 4 you can see that, since the top last November, the trend has not been as clear on the 2-day chart. Chart 4 – Current Position
click chart to enlarge
There was a higher top on 29 December and a higher one again on 2 February, but they didn’t push much higher than the November top. Wait a minute… The current top is 2 February. The top in 2010 was 1 February. In 2006 the bull market top was on 3 February. Could there be any significance in this?
Since the November 2010 top, a 2-day swing low has been broken on 3 occasions, straight after each top in November, December and February. On each occasion this was followed by a lower swing high. But after the November and December tops that was as far as it went. The next bottom was higher, and the next top was higher.
So if the low of 24 February can be broken, that would be a good signal that another bear market in Sugar is beginning. If the 2-day swing chart can then make lower tops, this would be another time to use it to keep you in the market the right way.
Knowledge is Power!
Tim Walker
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