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This chapter is from the book

Fortunes Made and Lost

By nature, when we think of a bull market, we assume that there are riches to be made. However, in an arena such as commodities in which it is just as common for traders to be short (sold futures in anticipation of lower prices) as it is to be long, this isn't necessarily the case. Additionally, the media's arguments against "greedy" speculators seem to imply that a majority of traders make money, and it is somehow easy to do so. This couldn't be further from the truth.

For every winner, there is a loser. Nonetheless, the winners get all the attention.

I learned this lesson the hard way in 2007. What I thought was going to be one of the best times in history to be bearish in the wheat market quickly turned into a nightmare as prices made new all time highs and didn't look back. Suddenly prices were moving more (against our clients' positions) in a single trading session than was often the case in an entire year. I recall our inaccurate speculation being made even more painful by the media euphoria in regards to the "riches" to be made in commodities.

Because of its profound impact on the economy and our daily lives, crude oil futures were in the center of the debate. Believe me, not all speculators in the energy complex made money as crude oil tripled in price. Crude oil is one of the most difficult markets to trade successfully, regardless of whether you are a futures or options trader. The margin requirement is extremely high, and so is the volatility and risk.

Unless you have deep pockets or a high tolerance for risk, energy futures are a treacherous market in which to be a speculator. A crude oil price chart can be deceiving in that it seems as though it would have been "easy" to make large profits by simply being long. Nevertheless, for the average retail trader, the intraday and daily price swings can be financially unmanageable and psychologically unbearable.

Try to imagine being long in crude oil futures as it bounced between $130 and $140 on its way up to nearly $150. A trader would have made or lost $10,000 per contract several times over, and that is hard to watch. It is likely that many retail traders gave up on the position before the market ever made it to its all-time high price. In theory, a trader might have been able to buy the dips to $130 and sell the rallies. Knowing what we know now, this would have been lucrative enough to afford a savvy trader a new luxury-priced car, but for many trading it in real time, it might have been pure agony. Better yet, imagine being long crude from the high $140s after hearing predictions for $200 crude oil from some of the industry's most respected analysts. We all know what happened next (see Figure I.3).

Figure I.3

Figure I.3 This chart is a continuous front month futures chart and is therefore an approximation and might not represent the most-active contract data. Nonetheless, the magnitude of the move is identifiable by this depiction. A trader exposed to the market during the entire move would have made or lost approximately $116,000 per contract!

The oil futures "tycoons" that you hear about on TV rumored to have netted millions of dollars buying crude oil futures contracts are few and far between. Those who were the beneficiaries of the now infamous energy rally were likely people who had significant risk capital backing their speculation or simply a magnificent streak of luck and an incredible amount of fortitude. Unlike you and me, the success stories were, based on my observations, traders that executed a position and stepped back without micromanaging the details or even losing sleep.

I will be the first to admit that I was wrong in my expectations of crude oil in 2007/2008. I never anticipated to see prices above the $100 mark, or at least not in such a short time frame. Clearly, I was wrong. Luckily, I was wise enough to realize that that the energy markets aren't for everyone. Although I recognize that my clients are free to speculate in any market that they choose, and there can be great opportunities in energies, I took the opportunity to kindly remind them of the potential hazards.

Ironically, based on my experience and conversations with those within the futures and options industry, the commodity rally was paralyzing for many veteran traders. The price moves were impossible for those unfamiliar with the markets to fathom, but for those that have been trading grains and energies for many years, it was not only unimaginable but in some cases career-ending.

Traders that spent the bulk of their adulthood speculating as grain prices moved from high to low within their historical price envelopes, quickly discovered that the markets no longer had boundaries. For example, prior to 2007 wheat was a commodity that was most comfortable trading between $2.00 and $4.00 per bushel with a few brief stints in the $6.00 range. Looking at a long-term wheat chart, it is easy to see how a trader could unexpectedly get caught on the wrong side of a move that eventually got close to doubling the previous all-time high of the commodity. Those that did find themselves in such positions were in a state of denial and had a difficult time liquidating positions with large losses. As a result, the situation became even worse as losses mounted, as did margin calls (see Figure I.4).

Figure I.4

Figure I.4 Few could have predicted the magnitude of 2007/2008 wheat rally that made a mockery of its previous all-time high.

You might have heard about the rogue (unauthorized and reckless) wheat trader whose actions resulted in a large loss at a major financial institution. The trader, without permission, greatly exceeded his trading limits due to a loophole in the trading platforms. The culprit was a commodity broker located in Memphis, Tennessee, who reportedly put his account, and ultimately his brokerage firm, in the hole more than $141 million. The broker had been a registered participant of the futures industry for more than 15 years at the time of the incident; perhaps in this case his experience worked against him in that he was overly bearish in a market that simply wasn't "playing by the rules."

Keep in mind that in a precommodity boom world, the margin to hold a wheat futures position overnight was less than $1,000. During its "hay day" it was in the neighborhood of several thousand dollars. Therein lies much of the problem, as commodities became more and more expensive to hold, short traders were forced to fold their hands. The liquidation of short positions added to the buying pressure of speculative long plays, and prices became astronomical.

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