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Larry’s note: Welcome to Trading with Larry Benedict, the brand new free daily eletter, designed and written to help you make sense of today’s markets. I’m glad you can join us. My name is Larry Benedict. I’ve been trading the markets for over 30 years. I got my start in 1984, working in the Chicago Board Options Exchange. From there, I moved on to manage my own $800 million hedge fund, where I had 20 profitable years in a row. And, I’ve been featured in the book Market Wizards, alongside investors like Paul Tudor Jones. But these days, rather than just trading for billionaires, I spend a large part of my time helping regular investors make money from the markets. My goal with these essays is to give you insight on the most interesting areas of the market for traders right now. Let’s get right into it… |
Trading commodities is off the radar for most investors…
They might not understand what drives commodity prices in the first place, or even how to trade them at all. To them, it’s much better to stick with something they know like stocks.
However, while commodities might not be for everyone, they sure can throw up a lot of trading opportunities. Especially when those commodities get on a roll.
The good news is that there are now many commodity-based ETFs on the market. So, you can simply trade them through your regular brokerage account. No special accounts are required.
Another benefit is that commodities don’t always have a high correlation with the broader stock market. Some commodities will be rallying… even when regular stocks aren’t.
One of the more common agricultural commodities that I follow is wheat. In the weekly chart of the Teucrium Wheat Fund ETF (WEAT) below, you can see how the long-term trend has formed a rounded bottom.
The 50-week moving average (MA – blue line) was trending down from the first quarter of 2019, before bottoming out around the middle of last year…
Teucrium Wheat Fund (WEAT)
Source: eSignal
With the 10-week MA (red line) crossing above the 50-week MA around the beginning of October 2020 (red arrow), WEAT has been in an uptrend now for well over a year.
However, as you can see, this uptrend in WEAT hasn’t been a straight shot. Along the way, there have been many countertrends where the price dipped.
In fact, if you check out the chart closely, you’ll notice that these countertrends in WEAT come along roughly every few months or so…
And that’s where the Relative Strength Index (RSI) can help fill in the picture (in the lower half of the chart).
On the RSI is our regular support/resistance line (green) at the 50% level. As you can see, apart from very brief periods in March and July this year, the RSI has stayed in the upper half of its chart for the majority of WEAT’s recent rally.
Another thing you’ll notice is that pattern within the upper half of the RSI…
Teucrium Wheat Fund (WEAT)
Source: eSignal
As the RSI has bounced off that green line (and formed a ‘V’), the WEAT share price rallied. And, when the RSI has pierced the overbought signal (upper grey horizontal line) or formed an inverse ‘V’, the WEAT share price fell.
It’s easy to generate a trading strategy by using these two lines on the RSI (upper grey and green support). Right now, although the RSI has not yet formed an inverse ‘V’, you can see that it’s closing in on overbought territory.
To generate a short trade here – to capture the countertrend – we’ll need to see the RSI form an inverse ‘V’. For now, we’ll wait patiently and see…
If you are interested in trading commodity ETFs, however, there are some things you need to know…
Given the difficulty in buying and storing commodities, many of these ETFs buy futures contracts to gain exposure – as does WEAT.
Because futures contracts continually expire, the fund has to roll out of (sell) the current contract before it expires and buy another wheat futures contract (with a further out expiry) to maintain that long position.
Given the longer time to expiry, those further-dated futures contracts are often more expensive than the ones they are closing out (selling). This is known as “contango.”
Meaning that the proceeds from selling the current futures contract won’t always cover the cost of buying the next one. While ETFs like WEAT spread those contracts out to reduce the effect of contango, sometimes it can’t be eliminated altogether…
And over a long period, this can eat away at the value of the ETF.
As this process needs to be actively managed, these futures-based ETFs will often have a higher expense ratio than a stock-based ETF, for example.
So, you don’t normally use futures-based ETFs if you’re a buy-and-hold investor. Instead, these ETFs are often better suited for active trading.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict
Reader Mailbag
What’s been your experience trading commodities? Is there a particular one on your radar?
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