Commodity Trading Strategies
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CommodityStrategiesHigh-Profit Techniques for
Investors and Traders
THOMAS J. DORSEY
TAMMY F. DEROSIER, SUSAN L. MORRISON, PAUL L. KEETON
OF DORSEY, WRIGHT & ASSOCIATES
WITH JOSHUA B. PARKER
Copyright C 2007 by Thomas J. Dorsey, Tammy F. DeRosier, Susan L. Morrison, Paul L. Keeton,and Joshua B. Parker. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New JerseyPublished simultaneously in Canada.
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Library of Congress Cataloging-in-Publication Data:
Commodity strategies : high-profit techniques for investors and traders/Thomas J. Dorsey . . . [et al.].
p. cm.(Wiley trading series)Includes index.ISBN 978-0-470-12631-8 (cloth)1. Commodity exchanges. 2. Speculation. 3. Investment analysis.
4. Commodity futures. I. Dorsey, Thomas J.HG6046.C662 2007332.644dc22 2007012415
Printed in the United States of America
10 9 8 7 6 5 4 3 2 1
CHAPTER 1 Developing a Trading System 1
CHAPTER 2 Patterns, Trends, and Price Objectives 13
Chart Patterns 14
Trend Lines 15
Price Objectives 25
CHAPTER 3 Using Spot Charts 31
Commodity Market Indexes 32
Spot Currency Charts 41
Other Useful Spot and Continuous Charts 48
CHAPTER 4 Relative Strength with Commodities 59
RS Calculation Example 60
CHAPTER 5 Other Strategies and Tools 71
Support and Resistance 71
Big Base Breakouts 75
Changing Box Size 77
Using Pullbacks and Rallies to Improve Risk-Reward 82
Trading Bands 90
vi COMMODITY STRATEGIES
CHAPTER 6 Putting It All Together 95
Part One: Old Friends with a New Trend 95
Our Approach 97
True DiversicationYou Dont Have to Go Far to Find It 98
Putting It All Together 100
Part Two: Initiating and Managing a Position 102
Risk Management 102
Stop Loss Points 105
Putting It All Together: Specic Trading Examples 110
CHAPTER 7 Exchange-Traded Funds (ETFs) and
Commodity Markets 129
Timing Is Everything 129
History of Exchange-Traded Funds 131
Todays Commodity/Currency ETF Market 133
Evaluating the Point & Figure Chart of Commodity ETFs 136
Relative Strength Comparisons 139
Know What Is Inside 147
What Does the Future Hold? 151
CHAPTER 8 Mutual Funds and the Evolution of the
Commodity Markets 153
From Fruit Baskets to Baskets of Fruit 153
Oils Well That Ends Well? 155
Soft Dollar? Try Franklins Hard Currency Fund 168
Thinking Tactically about Cash 172
Contemplating Cash 174
The Big Picture? 177
Commodity/Futures-Related Mutual Fund Vehicles 178
CHAPTER 9 Final Thoughts 179
APPENDIX : Commodity and Futures Reference Sheet 191
For those who were investing at the time, it was the most remarkable,previously unfathomable, day in market history. For those who werenot yet investing, it was still a day of mythical proportions. The day
I am referring to, naturally, is Monday, October 19, 1987. At Dorsey, Wright& Associates (DWA), we came to work expecting business as usual, but bydays end we experienced the largest one-day percentage drop in the DowJones Industrial Average ever recorded. The Dow Jones dropped roughly23 percent in one day, and after that the media began proclaiming a replayof 1929. DWA had been in business exactly 9 months and 19 days when thishappened.
That day was significant to our corporate history because that singlesession changed the entire direction of DWA. It was as if we were movingfrom one train track to another. You see, we started out as an OutsourcedOptions Strategy Department, primarily servicing firms that did not oth-erwise have this type of department in-house. The blame for the crash of1987 was initially placed squarely on the shoulders of the options market,however, and in particular portfolio insurance strategies and naked put sell-ers. Some firms were said to be on the verge of going under because of theoptions liability exposed on that fateful day. For most firms, though, thingsworked out. The market eventually rebounded, and today the tales of thatone market session are legendary. Most advisers havent been in the busi-ness long enough to have firsthand knowledge of October 19, 1987, but forthose of us who have, it is a day that will not soon be forgotten.
That day could be looked at as Wall Streets Big Bang. It marked thefinancial end for some, but the beginning for others. DWA survived, just asmost firms on Wall Street did, but that one day marked a new beginningfor Dorsey, Wright & Associates. For us, it meant moving away from theoptions business almost entirely, as I knew wholeheartedly at the end ofthat session that the options business would never be the same again. Iknew many firms would be enmeshed in litigation for years to come, thatI was likely to become an expert witness for my clients during this pe-riod, and that few firms would be increasing their options resources in the
viii COMMODITY STRATEGIES
near-future. That one day caused us to turn DWA around 180 degrees, push-ing the options business from the engine to the caboose of our train, andthe Point & Figure technical work to the front as our locomotive. It was anatural move for us, as we had employed the Point & Figure technical workin my Options Strategy Department at Wheat First Securities for years prior.But on that day, we were forced to begin marketing ourselves as technicalanalysts instead of options strategists.
On October 20, 1987, I created the first Dorsey, Wright & Associatescommodity report. I knew that if we were going to move out of the optionsbusiness, we would need to fill that hole with something. Commodity pricesare governed by the irrefutable law of supply and demand, making it aseamless application for our Point & Figure work. I look at most things inboth life and business in the most simple of terms. Copper is, quite simply,a hunk of metal. Cocoa is simply a bean that grows, primarily on the IvoryCoast, and from time to time the locusts will come and wreak havoc. Coffeeis similarly a bean that Juan Valdez and others cultivate down in Colombia.By the same token, IBM is simply a stock that moves about on the New YorkStock Exchange, its prices governed by supply and demand imbalances.What makes the movement of cocoas price different from the movement ofIBMs price? One could offer that there are no cocoa CEOs to be carried outof their offices in handcuffs for various improprieties. There are no claims ofcorporate malfeasance thrust upon live cattle. But in terms of what causesa change in price, there is nothing different between a share of IBM and acontract of coffee. IBM is to cocoa as coffee is to copper, and so on.