The Ideal Commodity Market Indicator

12/16/2011 10:47 am EST

Focus: COMMODITIES

Pratik Patel

Founder, Clear View Futures and The Futures Room

Commodity markets have exploded in popularity, and with the advent of commodity ETFs, traders have a variety of liquid choices for analyzing and trading price movement, explains Pratik Patel

A lot of traders are trading ETFs and futures around commodities, but what about trading or watching both of them at the same time? 

Our guest today is Pratik Patel to talk about that. So Pratik, how do I use the ETFs on commodities and the futures on commodities together?

Well a perfect example, I trade commodity futures, mostly the grain sector, and I also have a correlating ETF that mirrors that. Almost every single commodity out there—oil, gold, silver, the e-mini S&P, the currencies—have correlating ETFs that mirror them, and it’s not a 100% mirror, but it’s almost a 99% correlation between them. 

When I trade the grain commodities, I’ll look at the Powershares Deutsche Bank Agriculture Fund (DBA). It kind of mirrors the overall agricultural sector with all the grains: corn, soybeans, wheat, oat, ryes, you got live cattle, feeder cattle, you got all those Ag sectors.

So let's say I’m getting into a position and I want to see how this market is going to move. I might have an idea or set-up on the corn futures, and I’ll look at the ETF and see how they’re moving. 

If something is not right, I might want to reconsider that trade I’m going to put on, because you've got that almost mirroring effect. It’s kind of called a lagging indicator, but it gives you an idea of where it could potentially go. 

If I want to see something in maybe the ETFs and I want to see it correlating with the grains, then I might just step on the side and just wait to get another confirmation, so the ETF in a way confirms your set-up, confirms your idea on that trend or that trade.

A lot of times what I’ll do is let the markets open up and see how the ETFs open up. The ETFs will open up before the actual commodity markets will open up, so you get an idea of the pre-market activity and see what kind of activity other traders are seeing. 

One thing about the ETFs, it’s a higher volume traded than the commodities. The ETF is almost like a stock, so you got millions in volume in the ETF, so it gives you more of the traders' ideas of how they’re treating the ETF versus treating the commodity.

I’ll keep them side by side and balance technical indicators, set-ups, breakouts with both and see if they can go in one direction.

So when you say one is not acting right, are you talking about the fact that maybe the ETF is starting to roll over and the futures continue straight, and that might be a sign that something is about to happen?

That’s exactly right. Let’s say the ETFs are starting to move down and the grains are moving higher. That is just not looking right because the ETFs have more volume, they have more of an indicator of where the commodities will go, so eventually the commodities confirm and correlate back and they drop to where they’re almost matching. 

They almost flow in a percentage; let’s say the ETF is down 1%; you might see the grains come down maybe 0.8%, maybe 1.2%, but they’re going to kind of mirror each other. 

It’s going to be extremely rare to see them diverge. When they’re diverging, they’re going to come back and meet and converge back to parity. 

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