Skip to main content

Commodity markets not crazy enough for you? Just wait...

Equity markets have felt the impact of the quants and their algorithms for some years now. Commodity markets, on the other hand, have been a bit more old fashioned. Investors should be aware, however, that situation is changing.

Automated trading strategies are expanding into commodities as firms look to apply these techniques to other asset classes. And it's happening at a rapid pace. It is thought that as much as 35 to 50% of volume in the most active front-end oil contracts is generated by algorithmic trading.

There are differences in automated commodities trading when compared with the way it's done in equity markets. Here are the three strategies most commonly in use in commodities markets.

The first is called ETRM which stands for electronic trading and risk management. In this scenario, which comprises the majority of automated trading in commodities, there is actually a lot of human input driving the trading with assistance from fairly standard electronic trading systems configured with risk management add-ins.

Going further along the automation curve, the next level is referred to as PTRM. Here, algorithms implement a programmatic trading approach that supports the trading decision and the risk management is more tightly integrated into the whole process. This methodology is the next step for traders that wish to more fully embrace automation.

The fully automated approach as practiced by the most advanced quants in the equity markets has not quite arrived in the commodity markets but many bits and pieces are in place already at some firms. Trend following and fundamental-driven strategies are being implemented  in software to provide long, short or flat (cash) exposure as well as functionality that will look familiar to stock traders like trailing stops.

The commodities markets offer a rich environment for quants. There is a variety of trading strategies that can yield to automation: calendar spread trades involving contracts for different months, inter-commodity trades (crude oil versus refined products,  for example), seasonal trading, exploitation of price differences between exchanges, various kinds of pairs trades and more.

So put the computers into the hands of commodity speculators, stir in a little leverage and see how the big trading desks pile into similar trades faster and with bigger positions. With commodities representing finite resources and big money chasing after profits on the way up (with long strategies) and on the way down (with short strategies), moves can be expected to be quick and extreme with prices overshooting on the way and on the way down.

Hat tip to "Wall Street & Technology" magazine for providing source material for this post
Labels:

Comments

Post a Comment

Popular posts from this blog

Brazil - in a bubble or on a roll?

A couple of years ago, no one recognized the real estate bubble even though it was under everyone's nose. Now, analysts and bloggers are seeing bubbles everywhere they look. One of them, they say is in Brazil whose Bovespa stock market index has doubled in the last 12 months. Does the bubble accusation hold water? I don't think so and here are 7 reasons why Brazil is by no means a bubble economy: Exports have held up over the past year thanks to demand from China for Brazil's soya exports and iron ore. This was helped by the the Brazilian government's drive to improve trade links with Asia and Africa. Export diversification, spurred by a more active trade policy and increased focus on "south-south" trade under current president Lula, helped mitigate the decline in demand from OECD (Organization for Economic Co-operation and Development) countries A "sensible" economic framework has been in place since the 1990's. This has included inflation
4 comments
Read more

Thursday Bounce: Trend Busters, Swing Signals and Trend Leaders for July 9, 2009

This is a quick post to announce that we have published Thursday's Trend Leaders, Swing Signals and Trend Busters at Alert HQ . All are based on daily data. Today we have the following: 72 Swing Signals -- A couple of days ago we had 35 signals, today we have twice as many. Happily, we now have 65 BUY signals, a mere 4 SELL Signals plus 3 Strong BUYs. Whoo-hoo! 56 Trend Leaders , all in strong up-trends according to Aroon, MACD and DMI. There are 18 new stocks that made today's list and 60 that fell off Tuesday's list. 48 Trend Busters of which 5 are BUY signals and 43 are SELL signals The view from Alert HQ -- Talk about mixed signals. If you look at our Swing Signals list you would think the market was in the middle of a big bounce. BUY signals are swamping the SELL signals and we even have a few Strong BUYs. Yes, there's a good sprinkling of tech stocks and tech ETFs but the distribution is pretty broad-based with a good number of different sectors represented, eve
1 comment
Read more

Unlock Stock Market Profits - Key #1

This is the first in an ongoing series of articles where I discuss what I feel are keys to successful investing. It is based on a post that provides a summary of the ten keys that individual investors should use to identify profitable stock trades. ( Click here to read the original post ) There are two basic steps to investing. First, you need to find stocks that seem to have some potential. Then you have to determine whether these stocks are actually good investments. There are many stocks that at first glance look interesting, but further research reveals that there are too many negatives to warrant taking a position. This first post in the series starts at the beginning: getting good investment ideas. Key #1: If something special is happening to a stock, it will be reflected in some kind of unusual activity in the markets. As individual investors, we will never be the first to know; however, unusual activity can be an early sign that allows us to follow the Wall Street professional
4 comments
Read more