If your idea of the “perfect” job is to sit in a cubicle and shuffle paperwork then you should stop reading this article immediately because there is nothing mundane about trading futures. Each day is filled with glorious emotions that are offset by bitter disappointments and failed trades. Aside from you personal trading style, there are outside risks that need to be factored into the trading equation.
The type of risk I am referring to are outside factors that can affect commodity prices regardless of how well you trade. Some of those factors include:
Global Risk Factors
For better or worse, we live in an unstable world and nefarious events between adversarial countries is very real. We live in a world of finite resources and many commodities are concentrated in regional geographic areas. For example, some of the worlds largest oil deposits are located in the middle east. For the rest of the world, that means purchasing their oil supply with middle east countries. Trading agreements of this type can sometimes spiral out of control with extremely adverse consequences. I am dating myself here, but I can still vividly remember the Arab Oil Embargo and observing long lines of cars waiting to fill up, and it wasn’t too long before many of the gas stations ran completely out of gasoline. The president at the time was Jimmy Carter and he was forced to take drastic measure to reduce the United States oil consumption.
Further, regional conflicts can stop the flow of commodities from normally productive economies. Whether it is a terrorist attack or an all out war can spell real trouble and make trading the commodity affected can experience wild price swings and shortages. These are risks you cannot control through defensive trading techniques because the scope of the problem is global in nature.
Risks Caused by Speculators
Since most of the readers of this articles can be classified as speculators, as opposed to corporate hedging operations, speculators can sometimes move the market in very unusual patterns. Just try to figure out the bizarre machinations of the price movement on the S&P e-mini if you want proof of unusual movement. Most of this unexpected movement can be attributed to High-Frequency Trading which currently composes upward of 60% of total traffic on the contract.
It’s not unusual for speculators to get out of control and drive prices to overbought levels or oversold conditions. The dot.com bubble is a good example of speculators driving price to unprecedented highs that proved to be overly optimistic, to say the least
Keeping careful track of the context of the market and the level of speculation can aid in avoiding speculator risk. A great way to monitor speculator activity is through the Commitment of Traders report published the Chicago Mercantile Exchange which breaks down activity by category of trader.
Black Swan Events
Nicholas Nassim Talab recently identified events that don’t fit neatly into traditional market theory. Efficient Market Theory, Fundamental Analysis, and Technical trading have zero levels of predictability when a totally unexpected event occurs. These events generally occur without warning and can have far-reaching economic impacts on local and national economies. The market free-fall in 2008 was one of many Black Swan events that have occurred in our lifetimes. Black Swan events must be events that are not foreseeable with current trading technology and have far reaching consequences.
After Black Swan events occur you will find a rush by academics (usually trying in earnest to understand the event) and the television “talking heads” to rationalize ad nauseum that the events were predictable and trot out some individuals who claim to have foreseen the event unfolding. (Think Peter Schiff)
This has been a very short non-inclusive enumeration of risk factors that a trader cannot control. There are endless variations of the conditions described above, but in general, unforeseeable trading consequences fall under these categories.