Philosophy behind trading Commodity Futures

Discussion in 'Economics' started by jay21, May 26, 2011.

  1. jay21


    Hello Elite Traders !

    I am coming from trading stocks and options, and currently learning about the futures market. I am having a difficulty in understanding the philosophy behind it.

    The role of retail traders like us is Speculator. In stocks, the more the speculators, the higher the stock price would be.
    This would help increase the value of 401k, bank and insurance holdings, pensions, etc, which in the end would help the economy. Trading Equity Index and Precious Metals would follow the same philosophy.

    However, for daily life commodity futures like oil, grain, and corn, the more speculators, the higher their price would be. This would make regular people to pay more for gas and food. Wouldn't this hurt the economy instead? I am having a hard time trying to understand the purposeful contribution of speculators on these types of commodity.

  2. the primary function of futures isnt speculation, it's to hedge against risk for people who are in the commodity business or requires alot of commodities. It allows them to limit their maximum risk exposure.
  3. jay21


    So would you say that speculators are screwing up this primary hedging function ?
  4. Screwing up?

    Speculators provide liquidity and often establish price to the other side of the trade to the commercials selling forward.

    Commercials generally have a tangible position or take delivery speculators generally don't. The latter are necessary.

    Been "that way" since the 1840's in terms of grain.
  5. heech


    The purpose of equity trading isn't to "raise prices". If that was the goal, we should just all announce all NYSE stocks are trading at $1,000,000 tomorrow... and then we can all magically retire to the Bahamas and be done with it.

    The purpose of all these markets is price discovery. What's the appropriate price for a stock? Why does anyone ultimately want a share of stock at all? Not assuming there's a greater fool out there... If you were God, what's the fair value you'd pay for a share (or sell a share$ of GOOG? You'd pay (or want to receive instead) the future cash flow you get from that share of stock: dividends, possible value of the company if its acquired.... Adjusted for interest/risk. GOOG is worth no more, no less.

    If someone comes to me, God, offering to pay $10 for a stock that's only worth $9... I will happily borrow that stock from someone else and sell it to him, banking that $1 in profit. And if someone is willing to sell the same stock to me, God, at $8.... I'll happily buy it.

    Same logic holds in commodities. Buyers buy because they think some commodity delivered on a certain day is worth more than the current price; sellers sell if vice versa. Together we figure out the markets best guess of what that price will be. There's no reason to think informed speculators will only push prices in one direction.
  6. To put what heech said in fewer words.

    The market is an auction - nothing more nothing less.
  7. You're assuming that every speculator takes the long side of the trade. Duh, that's not possible, since if everyone is long, who's selling?

    Your question is so loaded it makes me think you are one of those know-it-all dumbasses who doesn't understand fuck-all about how markets work, including the very basic fact that for every buyer there is a seller.

    "Gee, guys, I'm just a novice and all, but I think speculators are fucking over regular joes by raising the price of everything. Am I wrong?"

    In other words, is that you Eric Holder?
  8. jay21


    This thread gets more interesting. Let me play devil advocate here.

    Real price is discovered when real supply meets real demand. Real oil price would be discovered when airlines meet oil companies.

    However, speculators does not take nor give physical deliveries. Thus, they are producing fake demand (or fake supply if short). The very presence of speculators distorts the real market.

    I do not really buy the "providing liquidity" argument because it can be solved by hiring a market maker/specialist to provide such liquidity.

    Now let me go to the other side.

    I do recognize that speculators create price competition. It prevents buy side to monopolize the sell side. It impedes Hershey and Nestle to dictate the price of chocolate, and make Starbucks difficult to dictate coffee price.

    The futures exchange also allows other commodity providers to make their products universally accessible, thus preventing a single big oil seller to dictate the price.

    Still, as far as I scretched my "other"side, i still could not find a justifiable cause for speculators _to distort the price of oil and food commodities.

  9. Yeah, here's an opinion. No one cares if you can find "justifiable cause for speculators".

    You're just not that important and never will be. Get over it and move on with your life because speculators aren't going anywhere. There's a ton of things I don't find "justifiable" (including this thread), yet, somehow, some way, those things continue to exist. It's called "reality".

    You're using all kinds of loaded terms to describe what speculators do, like "justifiable" and "distort" as though they have any objective meaning or, even if there is distortion, that it is anything beyond marginal relative to the price that would exist without speculators. Do you think oil would be priced at $5/bbl without speculators? $95? If the tradeoff I have to make is that oil be priced a few bucks a bbl more than it would otherwise be, but I get to live in a world where a man is free to risk his capital on a trade rather than have a panel of price-fixing bureaucrats tell him what the price will be, I'll pay the few bucks extra per bbl every time because at least there is some level of transparency in a market price, unlike a fixed price, which might only exist because some theory says that is the right price, reality be damned.

    Markets are not just about physical commodities, but about information. If a speculator, despite not having the tangible economic need to accurately price a commodity because that commodity is unnecessary for the speculator's day to day operations, is nonetheless able to successfully profit from trading that commodity against hedgers, it shows that the hedgers need to become better at information gathering. Look at the relative value created or destroyed by the airline hedging programs for further proof that even entities with massive incentive to understand the future evolution of market prices for major input costs are not able to accurately achieve that objective, while some speculators are and then tell me that the speculator whose forecast is accurate isn't providing valuable information to the rest of society about future price movements. If I see a successful speculator saying prices are going higher, I plan accordingly. Just because that might not be the message the rest of the world wants to hear or act upon doesn't mean anything. And, again, for every speculator who profits grandly there is a losing speculator or hedger on the other side of that bet and plenty of speculators lose to hedgers. Who are you to step in between those willing counterparties and tell them they have no justifiable reason to be transacting?
  10. jay21


    Dear logic_man,

    I was about to think that you use profanity to compensate an intellectual deficiency in conveying a precise meaning, but your second post proves me otherwise. You do bring some substance to the table.

    And no, I am not the Attorney General of the United States, so I am not gonna screw your ass.

    I am not endorsing price fixing. In fact, I am with you on market transparency. Government bureaucrats are definitely way inefficient compared to the market mechanics. But lets imagine a scenario where every oil buyer is a speculator, and you are a lone oil producer. What would happen ? Oil price would climb up to $140 where at the end of the month your oil still sits in the warehouse unsold. No real demand. Sounds familiar ?

    On the other side, lets say every oil buyer is a real buyer. What would happen ? I bet the oil price would be at $65 tops, its highest true cost. Similar scenario applies for food too.

    I agree with you about the market in general. Yes, market is about information. Information does change. As information fluctuates, so does the market price. However, for the oil market, a reality check shows that it is not about information. It is about big capital and excessive leverage that allows price manipulation. It is ridiculous to see that two traders with $50 mil have the capability to spook the oil market. In fact, they have the power to do so. Are they real price tellers, or mere thieves hiding behind laissez-faire legality ?

    In fact, I would argue due to its universal demand, oil is inherently not a free market. Nobody can live without energy, and energy comes from oil. The demand will always be there, increasing, insatiable. Same argument with food and healthcare. Nobody can live without them. Oil, Food, and Healthcare are naturally not a free market. In contrast, Gold is a free market, because even a gold bug can still live without gold around. Stocks too.

    How about that ?
    #10     May 27, 2011