There are four basic stop loss methods:

Initial stop. The initial stop is your insurance policy against catastrophic loss. The initial stop is the pre-determined price point at which you will cut your losses and pull out of the trade. To be successful, a futures trader must have the discipline to immediately exit his position when the initial stop is triggered. There will be times when the market will rebound shortly after your exit; but far more often, your timely exit will prevent financial disaster.

Break-even stop. Break-even stops prevent you from losing more than your initial buy-in. Once your trade moves above your entry price, a break-even stop is placed at the entry point to prevent loss greater than the initial buy-in. Once you pass the break-even point, you start playing with the market’s money, not your own.

Trailing stop. Trailing stops keep your profits from slipping away. They allow you to ride a potentially profitable trade without risking your hard-earned profit. Trailing stops track the lows. As the market edges up and down in small steps, stops are placed just below each successive low. By riding the lows in a slowing rising market, you place yourself in a position to continually gain while maintaining an acceptably small level of risk.

Time stop. Time stops keep money flowing and prevent you from tying up your money in unprofitable trades. A time stop forces you to sell if a trade hasn’t reached its price objective within a set period of time, generally not more than one to two hours and usually less. Time is money. If a trade doesn’t produce, move on.

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Because of the essential nature of commodities, in times of war and great turmoil, investors cling to commodities. For example, after the tragic events of 9/11, gold prices spiked as investors sought safety in the precious metal. Tragedy sends investors running to the basic, the dependable, the necessary, the things that are essential in our lives — to commodities. In times of trouble, investors consider certain commodities (particularly precious metals) to be safe havens for their money. It’s the end of the world scenario: In a devastated world without structure or law, gold will always have value. People will always be able to exchange gold for the things they need. Perhaps today the idea seems a little too Hollywood, but it persists, rooted in ancient human history throughout which gold has always signified wealth and power.

Inflation is another economic force that sends investors scurrying to buy up commodities. In uncertain times, people will always need the raw materials on which society is built and which are used to provide man’s basic needs — food, housing, clothing, transportation. While other sectors of the market languish as inflation rises, commodities will flourish. Gold, in particular, spikes during times of inflation. Because gold is the standard on which the world’s currency values are set, investors see gold as the ultimate hedge against inflation.

Commodities will not necessarily follow the stock market during times of economic pressure. Generally, commodities do well in periods of late expansion and early recession. As the economy slows, interest rates drop in an effort to stimulate the economy (witness the Fed’s slow but steady drop in interest rates over the summer and into the fall in response to the home mortgage and credit crisis). Low interest rates spur commodity growth.

It is important to remember that business cycles are not exact and cannot be predicted with definite accuracy. But they do provide a historical perspective that futures traders can use to evaluate commodities markets. It is also important to realize that not all commodities follow the same cycle (wheat may peak in the spring; oil, in summer). At any particular time, however, futures traders can usually find rising and falling commodities from which they can profit. Understanding what drives the economy and how those forces impact commodities gives futures traders important information they can use to take advantage of and profit from movement in the commodities markets.

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In current years, commodities have out-performed stocks. From 2002 to 2005, the Dow Jones Industrial Average returned a respectable 7%. During the same period, the Dow Jones-AIG Commodity Index increased a whopping 21%!

Risk is a matter of perception and knowledge. People (and investors are just folks) fear what they don’t know or understand. That’s where the commodity market gets its bad rap. Most investors just don’t know enough about commodities or how they work so they avoid them. Futures traders who take the time to learn about commodities and come to understand commodity markets gain an open playing field with plenty of room to maneuver.

What are the real risks in trading commodity futures?

Geopolitical risk. One of the greatest inherent risks in trading commodities is that the world’s natural resources are tied to physical geography which has been parceled out and is controlled by various world governments or sometimes by international companies. In order to access natural resources, companies must deal with and are often at the mercy of various foreign governments. The complexity of taking natural resources out of the ground and turning them into usable products is intense. Each government imposes on the process its own set of laws, way of doing business, cultural customs, tax structures, environmental concerns, employment requirements, technology network, etc.International disagreements over the control of natural resources are commonplace. Foreign developers can be unceremoniously booted out by the host country, losing their entire investment. If a country chooses to nationalize an industry — as Bolivia nationalized the natural gas industry in 2006 — the foreign developer loses everything in the blink of an eye, and has no recourse for reimbursement of his considerable investment.It’s difficult to protect yourself from geopolitical risk, but it pays to remember that in commodities, size matters. The bigger and more experienced the company, the more likely it is to succeed. Futures traders can use this information to determine probable risk.
Next time: Additional risk factors and how to manage risk.

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Elastic goods exhibit a high correlation between price and demand. When the price of the good goes up, demand decreases. Elastic goods are generally less-essential goods, meaning that you can live without them or at least use less of them or substitute a less expensive option. The dance between price and demand can be complex. For example, when the cost of milk rises, people buy less milk and fewer milk products. Some people will stop buying milk altogether until the price comes back down. Families with young children who still need milk will serve their children less milk or milk with a lower fat content and, therefore, cheaper price tag. They may substitute enriched soy milk or calcium supplements and calcium-fortified breads and cereals to ensure their children get a full dose of bone-building calcium. Sales on cheese, ice cream and other dairy products will plummet in concert with how necessary they are perceived to be. Ice cream is considered a luxury so when ice cream prices rise, sales fall.

Inelastic goods are goods that are so essential that consumers must have them no matter the cost. Price fluctuations have only a small effect on the demand for inelastic goods. Consumers may buy less, but they will have to buy some in order to survive. For example, in America oil costs have reached record highs. While it is true that some people are trying to cut back — making fewer and more efficiently planned trips to accomplish errands, car pooling, patronizing mass transit, walking more — the bottom line is that most Americans are dependent on their car. In most areas, there are no other options, you must drive your own car to get to work, get the kids to school, get to the grocery, etc. You may moan and groan, but you will buy gas for your car, no matter what the cost.

Most commodities are fairly inelastic goods. Commodities are the raw materials of our daily lives, the building blocks from which our homes are built, our clothes are made, our food is grown. We cannot survive in our world without the natural resources that are traded on the exchanges as commodities. In fact, it is the essential nature of inelastic goods that attracts futures traders. As long as man exists, there will be demand for commodities — and a way for futures traders to profit.

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Though some suspect the ancient Phoenicians and Greeks may have dabbled in futures trading, the modern futures market was born in Chicago with the establishment of the Chicago Board of Trade in 1848. Know as the hog butcher to the world, Chicago was also the commercial hub connecting Midwestern plains farmers with East Coast food merchants. Telegraph lines, railroads and shipping all passed through Chicago. It was to Chicago that Midwestern farmers came in the 1840s to sell the wheat that fed the world.

The crystal ball tells all . . .

Starting with the exchange of cash for the immediate delivery of wheat, trading gradually evolved into futures contracts in which a farmer would agree to deliver so many bushels of wheat to a dealer by a certain date in the future for an agreed price. Both parties benefited. The farmer knew how much he would be paid when he harvested his crop, and the dealer knew what his costs would be and how much wheat he could supply to his customers. Written contracts were often exchanged, sometimes with “guarantee” money. The Chicago Board of Trade (CBOT) came into being as a centralized location where buyers and sellers could meet, negotiate and finalize a contract. The first standardized “exchange traded” futures contract was listed on the CBOT in 1864.

Show me the money . . .

Contracts soon became so common that banks started accepting them as collateral for loans. Contracts also started to change hands before the delivery date. A farmer who couldn’t deliver his wheat might pass his obligation onto another farmer. A dealer who didn’t need the wheat might sell the contract to a dealer who did. Weather, locusts, disease, big harvests, flood, war, drought — all played a part in determining the final price of wheat when the crops were finally brought to market. In the interim, the contracts were traded back and forth. Soon the opportunity to make money on the trades attracted investors with no interest in the grain but a huge interest in the money! And the futures trader was born!

How to get some for yourself . . .

Today there are futures exchanges for wheat, eggs, petroleum, currency, metal, and other commodities. Futures trading still attracts people interested in those commodities and those who are fascinated by the potential to make money — lots of money. We can teach you how to do it! Click here to go to the Futures Trading Secrets website. Learn how to maximize your earning potential as a futures trader. The Futures Trading Secrets Course will teach you the success factors you need to master to make you a winner in the market. Click here to order the Futures Trading Secrets Course today.