Pitfalls

by Andy Waldock

Pitfalls of relying on the Commitment of Traders.

Due to the end use or, delivery of the commodity at hand, the Commercial traders do not have to get out of a position. This means that they do not sustain a realized loss, they simply have hedges that could have been better placed.

Commercial traders perform well as negative feedback commodity market participants. This means that they sell more as prices continue to go up and buy more as prices continue to fall. Their trading is based on their consumption or delivery needs and their sense of fundamental futures market value.



This brings us to the issue of trending markets and Commercial blowouts. Once the Commercial entity is fully hedged, they have an asset that needs to be financed, or a liability that needs to be fulfilled. Occasionally, a market moves so violently, or is so out of whack with its fundamentals, that the Commercials are unable to meet their obligations and must offset their positions in the futures markets.


The final pitfall in trading with the Commercials in trending markets is the Commitment of Traders Index. This is a popular indicator available in many data packages. It is basically a stochastic of Commercial trader movement. It is scaled from 0 - 100. It is usually traded as either an overbought/oversold indicator, or a momentum indicator depending on the individual. Its weakness is that it can read 0 or 100 for months on end in a trending market while providing neither the opportunity to get into a new position, or exit a losing position.




HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM.

ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS.