Martin Kronicle

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“Truths are first clouds; then rain, then harvest and food.” — Henry Ward Beecher

For the most part, I trade exchange-listed commodities, but there are dozens of commodities that don’t trade as such. The most important one of them is water. The growing 21st century “water gap” between supply and demand is going to have major ramifications for the entire planet.

There is the potential for the world to go from abundance to scarcity within 25 years. What does the world look like in 2050 when there are an estimated 9 billion people inhabiting the earth and they all want healthy food, hot showers, running water in their homes, and effective sewage? Will we create a “water footprint” and trade water conservation credits, not unlike the carbon market?

Water as Political Capital

On one hand we need large urban centers to begin aggressively conserving water, while on the other hand there are hundreds of millions of people in India and China who do not have running water. This is a global issue that’s not making enough headlines — and it needs to.

Colin Chartres is the co-author of Out of Water: From Abundance to Scarcity and How to Solve the World’s Water Problems and is the Director General of the International Water Management Institute (IWMI).

Colin’s book, co-written with Sam Varma, blew me away — as did this interview. I highly recommend the book.

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I wouldn’t want to be a CEO of an oil firm if my life depended on it. Everyone hates you. You have to deal with some of the most unsavory people in the world who steal, bribe, reneg, and lie to you all-the-while demanding signature bonuses. You at times put your own life at risk via your business travels. You have to have an appeasing Green ethos.

Back home in America, you have to deal with your own brethren who spit in your face, but at the same time want $2 a gallon gasoline consistently, as if it’s their birthright. That’s all before you have to deal with a lame President, House, and Senate who collectively could not come up with a National Energy Policy if their offices depended on it.

[As of this writing, the Department of Energy has not found America a single drop of oil. Alec Baldwin wants to shut down an oil company. Let's put the DOE down first Alec - I'll work with you on it.]

Tom Bower’s new book Oil: Money, Politics, and Power in the 21st Century is the best book on crude oil that I’ve ever read. Crude oil is a very complicated business. It is about 180 degrees out of phase with the simplicity of e-commerce.

Bower spoke with more than 250 industry professionals, politicians, and analysts over an 18 month period of time in order to complete this book. IMHO, I think academics and Liberals will learn the most from this book. It is written as the definitive history of crude oil – and it’s backed up by facts. Not make believe facts or Michael Moore Facts either, but real facts, that in the end provide readers with a well-rounded understanding of America’s addiction to crude oil and how we got here.

Read the rest of Big Oil Has Replaced Big Tobacco In The Bulls Eye of America’s Vitriol at the Huffington Post.

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I received several emails about managing risk with respect to my What Do You Make of Wheat post last week.

When the market goes parabolic and you watch your equity burgeon, you can actually become as frozen as if Jennifer Aniston herself asked you if you’d like to see the “way back” of her Range Rover. Stuttering and stammering isn’t sexy. You need to have an answer in the moment. For the record, I would be interested. In fact, there are some very interesting things that you may not know about the “way back” of a Range Rover that IMO one should definitely know about, but I digress…

A parabola – a mathematical expression for exponential growth or decay – doesn’t last forever and they consume themselves (or the host). You must act fast, whether you have galloping pneumonia or a highly levered portfolio in CBOT Wheat. A simple parabola is the equation y=x^2.

For the less experienced trader, I would suggest entering a Stop order to offset your position. I say “offset” b/c you can be long or short. In this case, you were long.

Entering the order serves two purposes:

1) the markets move too fast to try and day-trade out of a sizable position. Mishandle it and you will have substantial skid – skid that can be avoided if you order is “on the floor” or whatever is left of it. Almost all trading is done on the screen these days.

Second, it instills discipline in your trading. You’ve picked a spot where you’ll be financially and emotionally stable to offset your position. If you’re stopped out, that’s a good things: you don’t have any knowledge where the, ahem, bottom will be found.

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You’ll notice via the 5-minute bars, that the damage was done in the first 20 minutes of trading of the outcry session. Funny too, considering that 95% of all volume is done on the screen. There was plenty of time to offset the position before the “opening bell.”

However, if you waited for the market to open you were overrun with a wave of selling: you got caught in a $1.20 “long ruler” range day that might have left you paralyzed. Just as bad as watching the tail lights of the Range Rover drive away.

This is a question that has come in from at least a dozen readers recently in one form or another. I have summarized my responses to address all of the related questions.

Things are seldom what they seem, Skim milk masquerades as cream. – William S. Gilbert

Q: Can i ask why you have moved away from being a fully systematic trader? I feel that it would help in my understanding given that you are someone who has been successful systematically and yet do not remain fully systematic.

A: Mechanized systems serve a purpose, but are not the end-all or panacea. Using or running a “system” depends on what your personal needs are: the system is to serve you, not the other way around. If you want to, you can learn to trust yourself and trade on a discretionary basis. I know MARKET WIZARDS who regularly jump on and off systems…

Advantages:

They are good vehicles to learn trading.
They can help you catch some of the trend, but not all of it.
You must have the highest degree of discipline and integrity to run your system faithfully.
They are good for including many markets, and not just your favorites.
They can help you calculate position size, entry, and exit.
Can regiment consistent, small losses if programmed for such.

Disadvantages and Misconceptions:

Knowing how to trade a system does NOT make you a professional trader.
Knowing how to trade a system does NOT put you on the same level as a professional trader.
Having a system does not mean you will raise capital.
Running a system does NOT mean that you operate on a higher level of trading.
Having a system does not mean that anyone is going to care about you and your trading.
Systems are late to the game and give back a significant amount of paper gains.
Systems annul a trader’s intuition and innate ability to trade, if it exists.
Include far too many markets to become an expert in any one of them.
Price tells you a lot, but it does not take into account outlier events – good or bad.
Price does not tell you how other traders are positioned.

Today’s Environment

The reality is that we are in very difficult times for new or emerging commodity traders and CTAs. There is a big catch-22 in the market now. Might as well be called Catch 32, b/c that’s what you need in AUM to get an allocator’s attention: $32 MM under management PLUS a 3-year track record.

Most of my friends from growing up do not run mechanized systems. They’ve traded on the floor and “upstairs” and are generally specialists in one commodity – cocoa – or a sector – such as the energies. One good public figure in this realm is Eric Bolling. He traded Nat Gas spreads his whole life. Other traders I know traded Crack Spreads or were cannon-ballers in the Softs.

Other guys I know from the Nat Gas pit couldn’t tell you the difference between the S&P 500 and the Daytona 500. That means they didn’t know what the cash market S&P closed at from day to day. They were entirely focused on one commodity and they are worth 8 figures.

The most important thing I can teach anyone is that running a system is not the only foray into professional trading. As of this writing, I know of more places looking for a professional crude oil trader than I know those looking for new CTAs to allocate to.

That probably flies in the face of what everyone has read, but it’s the truth. In fact, a prop firm or hedge fund is not interested in your trading 25 commodities…but they’d be especially interested in your 2-3 year audited track record trading gold or crude oil though.

Your need for a system depends on what your goals are. If you want to try to be self-employed as a trader, gather assets, and become of member of the NFA, then learn to create system. Set a goal of 12% RoR per annum with no more than a 3-4% drawdown. Most of the people I’ve mentored or taught are very bright, but they are not marketers and that’s how you gather assets, and that is the pink elephant in the room.

If you want to trade on a prop desk or at a hedge fund, become a specialist in one commodity or a sector.

Associated Press

Wheat has gone parabolic on the confluence of news in Russia: a horrible drought, Russian wheat fields have gone ablaze and Glencore’s Russian unit is pushing for a grain ban on exports. All are fundamentals that cause tightness in supply, thus higher prices.

There are a few ways that you could have gotten long, but I’m more interested in how you are going to keep your paper profits before they go ablaze also. Below is a great study on how systems will get you into a trade, but can give back sufficient gains to leave you scratching your head.

Your clients and potential clients don’t need you to ride the wheat all the way up, and then give a significant portion back. They can do that without even trying. They bring the money, you are supposed to bring in the alpha.

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The wheat trendline is very steep. I’ve seen them ramp up like this and come back in 1/5 of the time. This poses a significant problem for the trader, especially the system trader. Why?

Well you’re supposed to follow your rules (if you’re listening to that judge in your head). My guess is you’re following a set of rules first introduced by Donchian – which means you’re looking at liquidating a long position on the ten-day low or when the faster moving average crosses the slower one. Let’s take a look at this mess.

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If you’re waiting for the trailing stop of a 10-day low or something like that to come around, you’re going to give back at least $1 per contract based on the levels today. That’s $5,000 per contract.

The settlement price was 6820 and the red line 10-day low is all the way down at 5822. And that’s a long way down. Easy to see. Easy to talk about. Hard to feel emotionally if you watch it come all the way back.

How do you reconcile the feelings of having the discipline to follow your rules with the feeling of not doing something proactive to preserve your capital when the market has given you such a gift?

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Above is the Donchian moving average calculations. Notice the black 5-day (the faster) crossed the blue 20-day (the slower) in mid June at about 4680. Settlement is the same at 6820. The 5-day is at 6560 and the 20-day is at 5924. Only God knows at what price the faster will close below the slower.

Keep in mind the trendline, which depending on the trendline you’ve drawn, appears to cross under the market at about the 6300 level – a full $0.50 or $2,500 per contract below the settlement price. You can use this to measure how overbought (or oversold in the case of a downtrend) the market might be.

When markets go parabolic like this or when they spike, you’re most certainly better off by utilizing one of two exit strategies – and the first one might surprise you.

Choose a point on a discretionary basis where you feel that you will be both emotionally stable with getting stopped out AND where you’ve preserved a great portion of the gains, which heretofore are only paper gains. This is about tradeoffs.

The second is staying long and utilizing an exit based upon a reversal pattern. At this moment, you have the fundamentals and the technicals going for you. Although the fundamentals might take several months to sort out – the total damage to the Russian wheat crop is unknown – the technicals might suggest a short-term downtrend before the longer-term uptrend continues.

It may be emotionally expensive for you to stay in for that ride, so there is nothing wrong with trading long then flat – in and out – until the trend has changed.

For the record, I would not be getting cute with this market either and try to trade a counter-trend position. If you think the world has gone nuts, then buy longer-dated OTM Puts on December wheat and let it play out. At least you can define your potential losses.

A good reversal pattern is the 2B Reversal Pattern that Victor Sperandeo wrote about in Methods of A Wall St. Master. From the book: “In an uptrend, if a higher high is made but fails to carry through, and then prices drop below the previous high, then the trend is apt to reverse…This observation applies in any of the three trends; short-term, intermediate-term, or long-term.”

So in this case, you’ll be looking for SEP to trade up to 7112 and fail. Then it could be lookout below.