Five Top Trading Tips for Active Traders (Part 5)

08/15/2008 12:00 am EST


John Person

CEO, John Person, Inc.

This is our fifth and final traders tip segment on trade management including your entry level, possible add-on levels, but most importantly where and how to set your stop loss or risk mechanism and profit targets.

The weekly gold chart below (4) shows the old high the point of breakout –pullback-consolidation labeled old support. If gold does hold the targeted monthly support at $847.70, and then if this is a potential low we should see confirmation by speculators significantly reducing their long holdings as revealed by the CFTC COT report. In addition, if my moving average system, Stochastics or MACD indicators flash buy signals then we can look to enter a long position going with the seasonal trend. However, we still need an exit strategy.

One fact is we could be right in the fact that gold prices could move higher from a seasonal perspective, but prices could decline further before that event occurs so it is prudent to make an exit strategy. One of my favorite sayings is “if the risk isn’t worth the reward don’t do the trade.” I would consider something significantly wrong with the market if the support level did not hold by seeing multiple closes below that horizontal level. So we need to discover if a thirty dollar or more stop loss order would have a disastrous impact on our trading capital. Trading a full sized 100-ounce gold futures contract, with a thirty dollar move would represent a $3,000.00 dollar value per position, so risk management is a key consideration.

Seasonal studies and technical tools can and do help time your entry and illustrate price support levels but not all trading plans go as expected. Setting a stop loss well below the long-term support or implementing a risk mechanism such as an option strategy can now be determined. As you examine the risks now you can even decide the trading vehicle you wish to trade an outright futures contract with, a stop loss or a futures contract backed up with a put option for protection, or going long a highly correlated stock like (ASA) or buying the ETF (GLD), or perhaps an option strategy on these vehicles. 
Traders can integrate an option strategy on a long futures position and such as a collar, which involves going long the underlying instrument selling an out of the money call and applying the collected premium to purchase a put option for downside risk protection. One could also simply buy a put and go long the market. Whichever route you wish to take it makes sense to see if there is an opportunity to go long the market and then map out your exit strategy if the trade does not work out.

One decision I would make is a daily close below the longer term support and resistance level and the monthly pivot support would have me exit the trade. My experience tells me if the market is in a bullish mode it should act bullish and typically it should not violate key support levels.  On the other hand if the market does react according to the seasonal tendencies, I need to manage the trade. In a collar strategy there is not much to do since that position limits your loss and at the same time limits your profit potential. If you choose the path of trading a futures position then you need to monitor the market and the price behavior. This is where weekly and monthly pivot point resistance levels will help give you and idea of profit targets

As a summary lets examine a recent case study in a market that just went under these criteria. This is a relatively less popular market but one I would guess may come under the media’s attention soon. The commodity is live cattle. As the COT report shows in table 2, you can see that the professional speculators and the commercials were both net long where the non-reportable positions (small speculators known as the general public) were net short by a very wide margin. Once again, let me remind you that the report was taken from the data as of the close of business on 7/22/2008 and released after the close on 7/25/2008.  This set-up signals a very bullish pattern.

Here is why this is a bullish set-up. First of all let’s look at the daily chart on the October futures live cattle contract. The bottom section shows beef prices seasonally are in a strong period this time of year. In addition, based on my moving average system, a buy signal was triggered. Plus, it was triggered near the monthly-predicted Pivot Point support level. The first chance you have to act on this information would be on the open outcry session on Monday 7/28/2008.

Now we have the information from the COT report that shows professionals and the commercials are long and the small speculators are short. Generally professionals will add to winning positions and small speculators will be forced out of their short positions and this requires one to buy. That buying action will put a bid under the market. The problem with some novice traders is they let emotions run their decisions and fail to admit defeat. Novice traders may also meet a margin call and stay with the loser or worse add to the losing position. The CFTC COT report has a lot to reveal when it comes to whose hands the market is in.

In the future, when trading commodity products do not forget to understand what the seasonal relationship and what hands the market is in by reviewing the COT reports.

By John Person of

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