Answers to Frequently Asked Questions
     About Trading Commodities

By Bruce Babcock

Q: How much money do I need to start trading commodities?

A: Studies have shown that the more money you have to trade, the better your chances of success. While some vendors (who want to sell you something) suggest you can trade with any amount you may have, most experts agree that with less than $10,000 your success depends on luck. You just don't have enough to diversify and apply proper risk management principles. If you do not have $10,000 in risk capital, you should stay in "learning mode" and paper trade until you do.

Q: Are options a good way for a low-capitalized investor to try commodity trading?

A: Absolutely not. Buying puts and calls is a sucker play very similar to casino gambling. You can win in the short term, but the more you buy puts and calls, the more you will eventually lose. When you buy a put or call, only a professional trader or a floor trader will be selling it to you. They do not sell unless the odds are in their favor.

Q: How do I choose a broker?

A: Whatever you do, do not depend on a broker for trading advice. With few exceptions, they are salesmen not traders. If they could trade, they wouldn't be brokers. I suggest one of the major discount firms in Chicago. Unless you require some special service not every firm provides, choose the one that will give you the lowest commission rate.

Q: What kind of returns should I expect from trading?

A: Risk is always commensurate with reward. If you are trying to "get rich quick," the high risks you will have to assume will probably break you. Commodity trading is not inherently risky. It is only as risky as you want to make it. Most people bust out because they can't control themselves and the urge to gamble. A disciplined person trading a solid, trend-following system with sufficient capital to diversify can reasonably expect consistent returns of 25 to 50 percent a year with drawdowns of 15 to 30 percent.

Q: Can I make a living trading?

A: If you are an exceptional person, maybe you can after several years learning and studying markets. Just as you can't learn to drive a racing car by reading a book, you will need a certain amount of trading experience to learn about markets and trading psychology. You will also need sufficient capital so that you are not trading with "scared money."

Q: How about day trading?

A: Find one person who has made a long-term career from day trading. Short-term price data is too random to exploit. This has been demonstrated mathematically. The only way to trade successfully is to follow trends. The trends you follow must be large enough so that the average trade result is greater than the costs of trading. Day trading does not permit you to do this on a consistent basis. Long-term trading is much easier.

Q: Do I need a computer to trade?

A: You cannot beat the markets by outsmarting them or other traders. Computers can make your analytical life easier, but successful methods are simple enough to apply without using a computer. Computers' real value, in my opinion, is their ability to help you test trading ideas historically. Most trading methods, even popular ones, do not work when put to a rigorous test. This is one of the great unspoken reasons why so many traders fail.

Q: Do trading systems really work?

A: Yes. Good systems that have not been over-optimized market-by-market do work. You must be careful to distinguish systems that work in hindsight testing from those that work in real-time trading. People assume that anything that worked over a long historical period will almost certainly continue to work in the future. That depends on the system and the test. There is no absolute relationship between historical performance and real-time future performance.

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