As beginner commodity traders you should definitely be aware of who is involved (and how much) in the formation of price movements in individual markets. There are two basic categories of traders – Hedgers and Traders each of which having somewhat different interests in the context of commodity trading.
Let´s look at their interests a little closer:
Hedgers are producers and buyers of commodities and they are the big players in each market. Hedgers are those who have the power and the upper hand in the market. Unlike us, their aim is not a speculation on commodity price movements and profiting on increasing or decreasing prices of futures contracts. If hedgers see an opportunity in the market and decide to enter into a trading position, they are able to buy really large amounts of futures contracts.
They are undoubtedly the best capitalised market participants. As producers or buyers of commodities they know the structure and rules of the markets much better than we – traders. It is important to realise that the market is not a place for speculation for them, it is their basic business. Their main and most fundamental concern is to minimise their potential losses, while we, traders, primarily want to generate profit. You can say: “What on earth means – to minimise losses?” I will explain it right now.
A hedger´s trading activities are always aimed at the commodity itself. In other words, a hedger has a genuine interest in the physical commodity because he needs it for his business activities. Let´s show this on an example from the chapter History of futures trading. If the rice-roll producer knew that the following year he would need 500 tons of rice and based on his assumptions he was convinced that the price of rice was going to rise, he would be logically forced to buy the rice as soon as possible, before the price increased. On the other hand, when the producer of rice rolls concluded that the price of rice was going to decline the following year, he wasn´t so keen on buying the rice. The fact is that despite the unfavourable current market rice prices the rice-roll producer had to buy a certain amount of rice because he needed it to ensure a sufficient amount of reserves for maintaining a smooth and reliable production of rice rolls (here we might apply the saying: “A bird in the hand is worth two in the bush.”).
Unlike us, traders, the core business (the essence of business activities) of hedgers is not profiting from speculations on increases or decreases in market prices. Their profits are guaranteed by their main business activities, i.e. by sales of commodities or products made from these commodities to end customers. Always keep in mind that hedgers are the biggest players in the market. It is said that they control 60% of the market. Hedgers are usually a few large corporations that actually form market prices. However, there are two opposite poles in this respect. On one side there are the commodity producers the interest of who is to sell the commodity for the highest price possible. On the other side there are their customers who want to buy the same commodity as cheap as possible because they use it as a raw material for their products.
Are you beginning to see the major advantage that we, traders, have against hedgers (large producers and buyers of commodities)? It is the right to choose when we enter and exit the market. It is a luxury that hedgers cannot afford. Hedgers must engage in exchange trading every day, whether they want or not, because they need to buy or sell commodities to ensure viability of their companies. We, however, have an invaluable possibility to choose the market and the time and volume of our engagement. This gradually leads us to the key finding: It’s all about the right timing and patience. You have to be able to wait for the right moment.
Traders can be further divided into two types – Small and Large Traders. Small traders, among which I include myself, have really only a marginal influence over market movements. Large traders can be funds or banks that do business in many markets within their diversified portfolios. Large traders represent a substantial part of the market structure. Their strategies are generally based on the “Follow the Trend” principle.
On the US markets boundaries between small and large traders are determined by the CFTC´s (Commodity Futures Trading Commission) regulations. The decisive aspect is the number of contracts that a trader buys or sells. The numbers of contracts defining large traders can be found at www.cftc.gov. CFTC is a commission that aims at ensuring clean and transparent trading in commodity markets. It monitors behaviour of large traders and hedgers (whether they are in long or short positions). In other words, Large Traders and Hedgers must send the CFTC weekly reports about their market behaviour – if they were buying or selling. Every week the CFTC publishes “CFTC report” in which you can see how the large traders approached the market. You can analyse their trading decisions and trade in the same direction as them. This is because large traders have a thorough knowledge of the markets and thus their behaviour can support or disprove our business analyses. You cannot have this unique advantage in Forex, nor in stock markets. In order to maintain affordable and realistic prices the big players´ activities are regulated. It’s a question of a higher interest –if the basic raw materials were too expensive, poverty would spread in the US and around the world. This gives us, small traders, a huge opportunity because we can actually “look under the hood” of the big player´s strategies. The truth is that we can make money in the markets via other and much easier analyses. We will tell you more about this in the next chapters of this handbook.
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