Commodity Investing: Maximizing Returns through Fundamental Analysis

CHAPTER 20

Some Building Blocks of a Commodity Futures Trading System

In this section we explore how one might start bringing together important information to construct a trading system. The key steps in constructing a trading system are (1) determining what the important information is, (2) constructing and testing a system or model to use the information, and (3) developing appropriate risk control. The purpose of this section is not to present a full-blown system, but instead to show how one might go about constructing such a system.

The main reason one would construct a trading system, of course, is to make money. But there are other reasons to develop methods for forecasting the direction a price is likely to go. An equity analyst who analyzes a commodity-producing company may find it useful to have a forecast, or at least a sense, of the direction in which the price of the underlying commodity is likely to go. Both producers and consumers of a commodity will have an obvious interest in future price movements. Fund managers and investors who are considering investing in passive commodity indexes may wish to look at some indicators to get a sense as to whether commodity future investments will offer a positive or negative return. So, even though this section presents the development of a simple trading system, its methods and tools have broader applications.

It is important to emphasize that it may not be possible to construct a trading system. Though it may be possible to ...