Trading By The Numbers

by Kevin Kerr

The old saying is “Buy the rumor, sell the news!” It’s usually good advice, but not always. Most big fundamental numbers are expected far ahead of time. It’s not like traders don’t know they’re coming or something. Now, an act of terrorism, a hurricane, a refinery explosion, political strife – those things are unexpected fundamentals that can move markets rapidly, because they come out of the blue; traders have no time to prepare and often have only a little information.

The numbers that come out each week and month usually come out the same day and time, so their announcement is largely anticipated. Many analysts spend their whole lives just trying to predict those numbers, and traders are bombarded by the media whenever a number is pending, as if the whole world’s future depended on the coming announcement. Usually, it’s not so dramatic. This is where the above saying comes from – the rumor is often much more volatile (and scary) than the actual facts.

For example: Let’s say that everyone is predicting huge drawdowns (in other words, a lot of usage) of gasoline. The EIA report comes out on Wednesdays at around 10:00 a.m. Now, if all of the market is frightened by the predictions of gigantic drawdowns the whole week before the report, the price is sure to rally. Then on Wednesday, if the report comes in and shows draws (usage) were not so high, or maybe even negative, sellers will fly out of their long positions even faster than when they went in. Much ado about nothing.

Speculation is based on this type of anticipation, and you can make a lot of money just riding the rumor higher, but be sure to get out or be flat, as we discussed earlier, before the number comes out. Holding a position through a number is pretty close to gambling – not a good word in the futures industry. One way to handle it is to take at least half of your position off before the number hits and grab some nice profits that will cover your other half of the position, should it go against you.

Have you ever heard the saying, “Life isn’t fair”? Sure, we all have, and have probably said it a few times, too. As in life, trading often doesn’t seem fair. As traders, it’s our job to look for value. But what is value, and how do you know if you’re getting it? Well, let me compare it to something you’ve done before. When you went to buy your last car, did you shop around until you found a good deal? Most likely you first decided on what car you wanted and then compared prices. After you found out the price, you began to negotiate and then eventually purchased the car. Trading is really no different.

Our first step as traders is to pick which commodity we want to trade. Then we need to find out where the market for futures and options is currently trading. We also need to see where the commodity has been trading recently, or even in the distant past (a long-term or seasonal chart is great for this purpose). Fair value, like so many things in life, is relative. In other words, what might seem fair to you may not seem fair to me, so we need a model that can be a basis for everyone.

With some technical indicators and charts, along with studies like Bollinger Bands (Bollinger Bands indicate when a market is overbought or oversold), a trader can get a good indication if he or she is buying the low or the high.

Fair value can also be calculated by many computer models out there, or via different trading platforms that do the calculations automatically. In particular, it’s important to determine what fair value is for the options based on where the futures price is at the present time.

When we want to get into a trade very badly, we can often rush into it; in other words, we don’t look before we leap. Always stop and think. Be sure to determine the fair value of a trade before you jump in. It will save much headache and stress later.

Editor’s Note: With 15 years of experience, Kevin Kerr is a true veteran of the commodities markets. A licensed commodities trader since 1989, he’s worked the trading pits in Chicago and New York with legends like Paul Tudor Jones, and he’s even traded commodity derivatives in London. Over Kevin Kerr’s career he’s dealt with everything from cotton to currencies to oil and natural gas.