Commodities and ETFs

October 12th, 2012
in contributors

Online Trading Academy Article of the Week

Which Commodity Index is Best to Follow?

by Don Dawson, Instructor, Online Trading Academy

Editor's note: This article was written 02 October 2012.

With the new Professional Futures class at Online Trading Academy we are focusing on a more broad Commodity Futures market. We cover different commoditiesSMALLasset classes each day to allow traders the flexibility to trade markets that have potential profit opportunities. Just like the stock trader who only trades one or two stocks, there are also traders who only know how to trade the E-mini Stock Index Futures. While it is good to know your market you trade, this style of trading does not allow for proper diversification. Many times the markets you have chosen to focus on are not moving and you end up forcing a trade because you feel like you have to do something. This is also called a boredom trade where a trader places an order just to feel like they are being productive.

Follow up:

By having the knowledge we teach you about the other Commodity asset classes you will be able to scan across different markets from Grains to Energy and everything in between. The opportunities to find trades become abundant.

When a trader begins their career in Stocks they are instructed to learn how to interpret the trend of the Stock Indexes before they place individual Stock trades. In general as the overall Stock market goes the individual stocks go. Buying individual Stocks in up trends is much more profitable than when the overall market is in a downtrend.

The Commodity markets also have an index we follow to gauge the overall strength or weakness of the Commodity sector. These indexes are made up of individual Commodity contracts to show us what the broad market is doing. Just like the S&P 500 is made up of 500 individual stocks these indexes have approximately 17 – 19 Commodities inside them.

There are a variety of Commodity indexes, but the oldest one is the Commodity Research Bureau (CRB) index. This index has been around since 1957 with many revisions throughout the years. Originally the index had 25 Commodities in it. Today there are 19 Commodities:

 

Aluminum

Cocoa

Coffee

Copper

Corn

Cotton

WTI Crude Oil

Gold

Heating Oil

Lean Hogs

Live Cattle

Natural Gas

Nickel

Orange Juice

Silver

Soybeans

Sugar

Gasoline

Wheat

 

The Commodities that make up this index are diversified, but the problem is the CRB index is heavily weighted towards the energy markets. Energy makes up about 34% of the index, so as energy goes this index gets dragged along with it. Figure 1 is a weekly chart of the CRB index covering the last 5 years.

Click on graph for larger image.

Many years later Reuters/Jefferies came up with the idea to create a balanced Commodity index. They believed the overall Commodity market was not fairly represented in the CRB index. The new index is called the Continuous Commodity Index (CCI). This index has 17 individual Commodities and are more evenly weighted to better reflect the trend of Commodities in general.

Cocoa

Coffee

Copper

Corn

Cotton

WTI Crude Oil

Gold

Heating Oil

Lean Hogs

Live Cattle

Natural Gas

Orange Juice

Platinum

Silver

Soybeans

Sugar

Wheat

 

Figure 2 is a weekly chart of the CCI index covering the last 5 years.

Click on graph for larger image.

Some ways a trader can use CCI is locating longer term Supply/Demand levels that reflect the broader Commodity markets. While the CRB index tracks closely to the CCI index you can notice subtle divergences at some market tops and bottoms. If the CRB index is making new highs and the CCI is lagging this is a sign that the energy market is pulling the index higher and not a broad market rally in the Commodity markets. When these appear a trader should expect a market trend change of some type.

Keeping an eye on the US Dollar index and the CCI index as they both come into opposing Supply/Demand levels can lead to some market moving trades. Since the majority of Commodities are priced in US Dollars the direction of the Dollar index will impact Commodity prices.

The following is not a trade endorsement or recommendation. It is intended for educational purposes only.

A trader can also invest in an ETF that tracks the CCI and participate in a Commodity market rally without having to trade Commodity Futures. This ETF is the Greenhaven Continuous Index Fund (GCC). I looked at the chart and it appears to track the CCI very well.

A Futures trader can trade the CRB or CCI on the Inter-Continental Exchange (ICE) as a Futures contract. Fair warning, this contract is very illiquid and may have a lot of slippage while getting orders filled.

The chart symbols for CCI and CRB vary from different software packages. I would encourage you to contact your data provider and ask for the CCI index. Track this index and you will be able to tell when the overall Commodity market is in an uptrend or downtrend.

As of this date the CRB was trading at 303.74. The CCI was trading at 569.70.

“We must let go of the life we had planned so as to have the life that is waiting for us.” Joseph Campbell


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About the Author


don-dawsonDon has been trading the futures markets since 1987. His perseverance through the ups and downs of trading, openness to experience of others, balanced tolerance for risk and patience to wait for his setups are a few of his strengths as a trader.

Don obtained his series 3 license in 1990. Soon afterwards he registered as a Commodity Trading Advisor with the National Futures Association and formed his company Majestic Futures. He has been a guest speaker on Technical Analysis at Johns Hopkins University and a guest speaker on the Business of Trading Radio Show in Washington, DC.

He continues to actively trade his personal account on a daily basis when not teaching for Online Trading Academy. His teaching method has been referred to as “down to earth”. He understands the student’s need for a structured environment in the early stages of their trading education. He uses humor to convey information in an accessible way.










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