Introduction
Commodity trading provides an interesting opportunity to expand your investment portfolio. Also, it allows for exposure to various markets that consist of raw materials such as gold, silver, crude oil, or agricultural products like wheat and soybeans. Participating in commodity trading can be profitable; however, it will require discipline and knowledge to avoid all the associated pitfalls. Unfortunately, many traders, especially new traders, fall into the same traps, which may restrict profits or even create substantial losses. Below are some commodity trading guidelines to help you avoid typical errors that traders make and get you on the road to success in commodity trading.
To Attempt to Predict Market Reversals Without Evidence
One of the greatest mistakes you can make in commodity trading is trying to "outsmart the market" by predicting reversals without having sufficient evidence. Betting against the trend can often lead to losses, especially given the volatility in many commodity markets. To solve this problem, always trade in the direction of the market. Utilise simple indicators such as moving averages or an RSI to show market direction. For example, if gold is showing an upward trend, while engaging in a short sell or reversal may be tempting, do not do so without sound support to provide a basis to perform the trade. Always use data to back your trades.
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Overlooked Stop-Loss Orders
Not utilising stop-loss orders is dangerous and could expose you to surprising market swings. A stop-loss will exit your trade at a determined price, preventing you from facing significant losses.
Without a stop-loss, it is possible to stay in a losing position too long and hope for a reversal. You can set an automated stop-loss order on your trading platform to remain disciplined. For example, when trading crude oil, determine where your exit is before you enter the trade. This simple step will help you not to let emotions influence your decision-making.
Underestimating Position Sizes
In today's commodity market, over-risking a position can completely wipe out your capital if prices reverse trend against the position. Most markets are volatile, and holding a prominent position increases risk and requires funding capital quickly. A clever approach is to risk only 1–2% of your positions based on your total (available) trading capital on any single position. Limiting your position size will help protect your portfolio from a significant swing and leave room for multiple trades.
Trading Based on Emotion
Fear of missing out or the desire to recoup losses quickly can cause a trader to overtrade. Initiating too many trades daily adds transaction costs and will influence your decision process. To avoid this circumstance, trade according to a plan that you have previously devised. Determine how many trades you will execute in one day and adhere strictly to entry and exit criteria. For example, if you are trading silver futures, allow yourself one or two high-conviction scenarios to pursue. A predetermined plan will help you stay focused and eliminate overtrading and emotional decisions that will likely not be found in a reasonable decision-making process.
Ignoring Trading Hours
Certain commodities have defined trading hours. If you are unaware of that, you may experience execution issues or miss out on opportunities. Traders should only trade periods of high liquidity. For example, new price action begins at the opening of a market, and liquidity is likely to be enhanced by market size, including trades conducted in Asia that exhibit prices in North America. Look up and know the trading hours for any commodity before trading it. Additionally, if you trade during high liquidity hours, whether the highest liquidity exhibits with higher probability, it is favourable for your trades to be acknowledged accordingly.
Overlooking Risk Management
Global events, supply/demand fundamentals, and geopolitical developments impact the commodity markets. These factors mean that commodity markets can experience rapid price movements. If risk is not managed correctly, you will be subject to a significant risk of loss. Use strategies such as hedging with correlated assets or setting stop losses to protect your capital. You may also want to look for opportunities across the following market structures of varying metals, energy, and agricultural commodity products. Aim for a risk-to-reward ratio of at least 1:2, meaning you target $2 in potential gains for every $1 risked.
Ignoring Expiration Dates
Futures contracts in commodity trading have expiration dates. Ignoring futures expiration dates can result in forced liquidation, rollover costs, or even obligations for physical delivery in specific agreements. Always be aware of the expiration dates for your contracts and make plans to either liquidate before expiration dates or rollover to the next contract. Be mindful to review your proper positions regularly so you can avoid surprises. For example, if you're trading on soybean futures, check the expiration date very early in the trading period so you can determine whether to liquidate or assume the next contract.
Trading without a strategy is like sailing without a map; you may drift aimlessly, almost always resulting in losses. Develop a trading strategy that incorporates goals, expected trading outcomes, risk tolerance, and clear entry and exit criteria. Keep a trading journal to outline your rationale for entering an order and often reflect on these entries. This will enable you to create a helpful distance from your trading emotional state and develop strong trading strategies over time.
Conclusion
With these tips to avoid common trader errors, you can increase your odds of succeeding in commodity trading. By using some discipline, carefully utilising technical tools, and managing risk, you can have confidence and certainty in your trading when you see the "trade" presented to you. These commodity trading tips can help you form a sustainable plan that meets your financial expectations.
Explore more: Beginners' guide to Commodity trading | Commodity trading- Risks and Benefits | Difference between Stock and Commodity Trading