Making Money In Quiet Markets With Statistical Thinking

For an investor, the commodity futures markets can provide some of the most lucrative returns in their portfolio. At the same time, the risks can be high. Investors are therefore looking for a trading strategy that maximises the returns whilst minimising the risks. The designers of such trading strategies are known as Quant (short for Quantitative) Analysts.

Over a 5 year period, I was a quant analyst for one of the world's largest soft commodity trading companies. During this time, the technical strategies I designed and traded were profitable or broke even in every year. For the fundamentally based trades, 90% were profitable over the same period.

Quiet Markets Are Bad News For Non-Statistical Thinkers

Cocoa is one of the most exciting and volatile commodity markets in the world. The supply of cocoa mostly comes from third world equatorial countries that are prone to political upheavals and extreme weather events such as El Nino. This means the price of cocoa has varied enormously in the past. However, the time I was working in the cocoa market between 1993 & 1997 turned out to be one of the quietest times in the market's history. Most investors during this time lost money in the cocoa market but I was one of the few to make money by using a mixture of technical and fundamental strategies

Trading Strategies For Statistical Thinkers

A technical trading strategy is one that uses the price history to decide if it is time to buy or sell. One of the simplest ways to do this is to calculate the moving average of the price. The strategy is to buy when the average starts to go up and sell when the average starts to go down. This is a good strategy if the price is following a sustained trend either up or down but is a poor strategy when the market is constantly changing direction.

A fundamental trading strategy uses other information to forecast what the price will be in the future. This forecast is then compared to the price today an   d the strategy is to sell if the price is above the forecast and to buy if the price is below the forecast. One of the best ways to forecast commodity prices is to estimate the global stock levels of the commodity as the price is often strongly correlated with stock levels. This is the case with cocoa as can be seen in the chart here. If today's price is £1200 and you think there are only 4 months of stock then you should buy whereas if you think there are 6 months of stock, you should sell.