Commodity trader types

From hero to zero

There are some characteristic power trader types in the current market.

The technical analyst trader bases his strategy solely on charts to make trading decisions. He is of the opinion that the past price action reflects the future price action. All information is reflected in the current prices. This trader does mainly trade long-term power, emissions or oil or some other liquid commodity. He can be funny and entertaining but is often late to join the party. Most of the action is over when he initiates a trade so he often ends up taking a stop loss.

The fundamental trader bases his strategies on fundamentals. He is a rational and calm trader, who rarely gets out of balance. The problem with his approach is timing. He can be correct about his proposition and but sometimes resist to cut losses if his position does not work out. But in the power market and other commodities governed by fundamentals he usually makes money over time. As a person he can be a bit boring and nerdy but is trustworthy.

The cowboy trader has very little knowledge about both fundamental and technical analysis. He is a bit lazy so he asks other people for advice. Then he puts on a mega position. If he makes money he is a hero. If he loses, he blames the analyst or other people who advised him. As a person he would be characterized as stupid or risk-seeker (i.e gambler). He has very limited knowledge about money and risk management.

The hyped trader had one or a few good years. Others consider him as the great trader but he is unable to pull the trigger now as he mainly made money in bull markets where any trader could make money. In a bear market or range bound market his strategy is vulnerable. As a person he can be difficult to work together with and he seeks to blame other for not supporting him to make money.

The best traders are able to make money in all kind of markets, However what really differentiated them were their ability to take a stop loss when they were wrong and even turn around. Many of the best traders are trading many markets simultaneously and therefore easier can identify trading opportunities in various markets. The drawback of this approach is at requires more preparation and research of trading opportunities. Some traders started with a top down approach by analyzing the macro outlook and charts periodically. Since the financial crisis, assets have correlated stronger with EURUSD, equities and commodities (most notably oil) having a high correlation. They were able to utilize market inter-relationship analysis. If one market had risen a lot while the other markets were lagging it could be a sign that this market had gained too much compared to the other markets. Other traders were solely focusing on one commodity market such as power but at various geographical locations and over time. There is also a difference in organization between some of the best performing traders. Some relied on a team to advise them while others were using mainly their own analysis and executed trades by themselves.

Conversely the poor traders appeared to do little homework and were utilizing external analysis without questioning assumptions. Likewise they were overusing charts and technical analysis which can be dangerous in commodity markets which rely stronger on fundamentals. Additionally they demonstrated poor risk management and not listening to what the market was telling them. In power markets there is often a strong relationship between the spot price and the short-term part of the forward curve which also could feed into the long-term part of the forward curve. Therefore it is crucial to have a strong understanding of the spot price and its outcome versus expectations.

Finally psychology played a role. If traders succeeded with their strategies they had more confidence which created a positive feedback loop. Conversely a failure created a negative feedback loop.

Some traders are risk averse and afraid to take large positions. They can quickly take stop losses if a position goes against them. They do not have great conviction in a trade and believes that the market always is right. Conversely some traders can take a large position when they have conviction when they were of the opinion that the market is wrong. This behavior is similar to George Soros trade against the British pound in the eighties. Some of these traders even doubled their position if they were in red but still believed that the market was wrong. The saying was that when in trouble, then double!

One major observation is because of the upward trending market till mid 2008 it was difficult to identify the strong and weak traders. However after the arrival of the financial crisis the markets have been trading down or sideways. This differentiated to skills of the traders. Traders who earlier used leverage in a rising market were mainly lucky and not skilled. This is analogous to funds making vast amounts of money in the stock markets till 2007 by mainly buying and utilizing leverage. The financial crisis revealed bad banks, frauds and poor traders. Additionally competition was less in the earlier 2000.


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