Drawdown
1
$2.79
$500.00
$0.00
$500.00
2
$2.75
$500.00
$200.00
$1,200.00
3
$2.71
$500.00
$400.00
$2,100.00
4
$2.67
$500.00
$600.00
$3,200.00
5
$2.63
$500.00
$800.00
$4,500.00
6
$2.59
$500.00
$1,000.00
$6,000.00
7
$2.55
$500.00
$1,200.00
$7,700.00
8
$2.51
$500.00
$1,400.00
$9,600.00
9
$2.47
$500.00
$1,600.00
$11,700.00
10
$2.43
$500.00
$1,800.00
$14,000.00
11
$2.39
$500.00
$2,000.00
$16,500.00
12
$2.35
$500.00
$2,200.00
$19,200.00
13
$2.31
$500.00
$2,400.00
$22,100.00
14
$2.27
$500.00
$2,600.00
$25,200.00
15
$2.23
$500.00
$2,800.00
$28,500.00
16
$2.19
$500.00
$3,000.00
$32,000.00
17
$2.15
$500.00
$3,200.00
$35,700.00
18
$2.11
$500.00
$3,400.00
$39,600.00
19
$2.07
$500.00
$3,600.00
$43,700.00
20
$2.03
$500.00
$3,800.00
$48,000.00
21
$1.99
$500.00
$4,000.00
$52,500.00
22
$1.95
$500.00
$4,200.00
$57,200.00
Gross
$8,800.00
Commissions
–$1,320.00
Net
$7,480.00
15%13%
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9-4
Corn Scales: 25% 10-yr. RangeScale: 4 cents down; 8 up1TradeCount12345678910111213GrossCommissionsNet
2Buy Price
3MaintenanceMargin
4TradingLoss
5CumulativeDrawdown
$2.43$2.39$2.35$2.31$2.27$2.23$2.19$2.15$2.11$2.07$2.03$1.99$1.95
$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00
$0.00$200.00$400.00$600.00$800.00$1,000.00$1,200.00$1,400.00$1,600.00$1,800.00$2,000.00$2,200.00$2,400.00
$500.00$1,200.00$2,100.00$3,200.00$4,500.00$6,000.00$7,700.00$9,600.00$11,700.00$14,000.00$16,500.00$19,200.00$22,100.00
$5,200.00–$780.00$4,420.00
23.5%20%
brokerage firm representing their good faith that they will be financially responsible for their actions (buying and selling) in the market. There are two types of margins, initial and maintenance. Initialmargin is the amount a trader must deposit to open a position.Maintenance is the amount the trader must maintain in the accountat all times to hold a position. The maintenance margin is lowerthan the initial margin. For example, the initial margin for corn maybe $650. The equivalent maintenance margin might be $500.This means that when you open a corn position, you deposit,or you must have in your account, $650 for each contract. If in thecourse of trading the price of corn drops to a level at which youhave less than $500 per contract in your account, you wouldreceive a margin call. The account papers you sign when you openan account require margin calls to be met promptly, usually within
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T A B L E 9-5
Corn Scale: 33% to 10-yr. LowScale: 4 cents down; 8 up1TradeCount
2Buy Price
3MaintenanceMargin
4TradingLosses
5CumulativeDrawdown
123456789101112131415161718192021222324252627282930313233343536
$2.79$2.75$2.71$2.67$2.63$2.59$2.55$2.51$2.47$2.43$2.39$2.35$2.31$2.27$2.23$2.19$2.15$2.11$2.07$2.03$1.99$1.95$1.91$1.87$1.83$1.79$1.75$1.71$1.67$1.63$1.59$1.55$1.51$1.47$1.43$1.39
$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00$500.00
$0.00$200.00$400.00$600.00$800.00$1,000.00$1,200.00$1,400.00$1,600.00$1,800.00$2,000.00$2,200.00$2,400.00$2,600.00$2,800.00$3,000.00$3,200.00$3,400.00$3,600.00$3,800.00$4,000.00$4,200.00$4,400.00$4,600.00$4,800.00$5,000.00$5,200.00$5,400.00$5,600.00$5,800.00$6,000.00$6,200.00$6,400.00$6,600.00$6,800.00$7,000.00
$500.00$1,200.00$2,100.00$3,200.00$4,500.00$6,000.00$7,700.00$9,600.00$11,700.00$14,000.00$16,500.00$19,200.00$22,100.00$25,200.00$28,500.00$32,000.00$35,700.00$39,600.00$43,700.00$48,000.00$52,500.00$57,200.00$62,100.00$67,200.00$72,500.00$78,000.00$83,700.00$89,600.00$95,700.00$102,000.00$108,500.00$115,200.00$122,100.00$129,200.00$136,500.00$144,000.00
GrossCommissionsNet
$14,400.00–$2,160.00$12,240.00
10%8.5%
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24 hours, or the brokerage firm reserves the right to close out theposition(s). In practice, you normally get more than 24 hours, onceyou have established a relationship of trust with the firm.Here is an example. Corn is trading at $2.50 per bushel whenyou buy your first contract. That requires $650 in margin. Over thenext week or so, corn loses a nickel and is trading at $2.45, a loss of$250 ($0.05  5000 bu). The $250 is subtracted from your $650 of initial margin resulting in $400. You must bring that up to the maintenance margin level of $500. Therefore you get a $100 margin call.Now this may not sound like much, but in our example(Table 9-3) corn drops from $2.79 to $1.95 or $0.84. A contract thatwas worth $13,950 ($2.79  5000 bu) is now worth $9750 ($1.95 5000 bu), a loss of $4200. Additionally, as corn tumbles, the scaletrader picks up a total of 21 additional positions requiring $500each to hold them. As you can see, the cumulative drawdowngrows to $57,200 in Table 9-3. In other words, either a sufficientamount of equity is deposited initially or the scale trader faces along series of margin calls. The former is preferred as will be discussed in Chapter 11, when we talk about the psychological sideof scale trading.As mentioned in the examples, I used the maintenance marginin budgets. I do this because as the commodities descend to thelow, you are only required to keep the maintenance margin to holdthe positions. As you add positions and are charged the initial margin, you build up a reserve of $150 per contract in the case of corn,because you only need $500 to hold a position. This reserve coverssome of the later initial margins as positions are added and gives amore accurate picture of the amount of equity required. Eventually,all positions in a scale are being held at maintenance margin levels.The margin figures I use in my examples may be different fromthose in place at the time you read this text. They could be higher orlower, as was discussed previously. I just mention this againbecause traders new to futures tend to forget this fact and react negatively to the change when it occurs unexpectedly. It is just a fact oflife as a futures trader that margin rates are always subject to changewithout notice. There may come a time when you are in a scale andthe margin is increased, generating a major margin call. This isanother reason to maintain an adequate reserve in your scale trading account. In my experience as a trader and broker, however, it isa very rare occurrence.
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Notice how the return from the basic scale varies in Tables 9-3,9-4, and 9-5. Again, oscillating profits are not considered. Oscillatorsare real and dependable over the long haul, but you never know inadvance which market is going to have the most volatility. Volatilityis generated by news events mainly. Accordingly, it stands to reasonthat summer is usually the most volatile season for grains, becausethat is when the supply is created. The bulls stampede every time itis too hot or too dry in the Midwest, and the bears are seen dancingaround the campfires when it rains.Table 9-3 has a gross return of 15 percent with commissionspaid out of oscillating profits. Table 9-4 is 23.5 percent and 9-5 isdown to 10 percent. The first scale is based on entering the marketwhen corn reaches the lower one-third of its 10-year trading range.Corn prices retreat to the 15-year average low turning point andmove higher.In Table 9-4, the trader waits until corn reaches the lower onequarter of its 10-year trading range before beginning a scale. Again,corn reverses at the 15-year average low turning point. By waitingto enter the scale, the return is increased to more than 23 percent.The difference is that the drawdown is less, thus reducing the equity needed to cover the drawdown and improving return.In the last example, the scale begins at the lower one-third ofthe 10-year trading range. Unfortunately, corn makes a new low,plunging to 3 cents below the old low. This is expensive in time andmoney. The return is a paltry 10 percent.Which is the best situation? At first blush, scenario number 2appears to be the clear winner. But the unknown factor is the number of oscillating profits. These are often the deciding factor. In scenario 1, the trader could get several oscillating opportunities as thebulls fight to prevent corn from getting away from them as the scalebegins. The fascination of trading is that no one knows the future.The bulls can be just as convinced of what they expect to happen asthe bears. Like all tugs-of-war, one side eventually dominates.When this happens, there is a sharp and distinct movement inprices one way or the other. This continues until some of the buyersbegin to think the move has gone too far. They challenge it. Youenjoy oscillating profits when this occurs.What you do not know in advance is whether it will happen atthe one-third or the one-quarter level. If you enter at the one-third
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level and a lot of oscillations occur after you are in, you will feel youentered the scale too soon. If you enter at the one-quarter mark andthe excitement is over, you’ll feel you got in too late. You’ll look at thecharts and see the wonderful oscillating trades you missed.Too early or too late—how can you always be right on time?The answer is you cannot. Traders with years of experience, whocontinually review their completed scales and journals, notice patterns of activity often reflected in the supply-demand numbers.These signals also appear on price charts and other technical analytical studies, particularly those related to volatility. A sixth sensedevelops. These scale trading pros can sense oscillating profits, theway a predator smells its prey. From year to year, these patternschange and evolve. Developing a detailed trading journal is one ofthe key elements to becoming a pro, because you capture yourexperiences for future reference.When you experience a situation like the one illustrated inTable 9-5, you must learn to make the most of it. You have almost$150,000 in the market and only a 10 percent return to show for it.On the other hand, these can be good experiences if you are prepared financially to handle them. The reason is the commodity market tends to overreact to everything. This is because the speculatorshave huge amounts of money on the line and they are attempting topredict the future. The pressure of the money at risk and the inability of not being able to foretell the near-term future leads to a herdmentality. Just as in those old-time western movies, an unexpectedshot in the dark sends all those “dogies” stampeding.You, as a steady scale down and scale up trader, profit fromthis behavior. You can take it to the bank that the corn market willnot smoothly move from $2.79 to $1.39. It will gyrate; it will rock’n’roll; it will act and overreact. The herd will be overly bearishonly to turn overly bullish the next minute. You only need to studyhuman nature and historical price charts to see this is true.I have also included a silver scale (see Table 9-6). I have donethis to show that returns can hold up even when margins arehigher. Silver contracts call for 5000 troy ounces; corn, 5000bushels. Silver’s maintenance margin is often twice that of corn,yet the results of a similar scale are not dissimilar, the big difference being the amount of reserve you would need to trade silverversus corn.
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154
TA B L E
9-6
Simple Silver ScaleScale: 5 cents down; 8 up1Number
2Buy Price
3Margin
4Loss
5Cumulative
12345678910111213141516171819202122232425262728293031323334
$4.73$4.68$4.63$4.58$4.53$4.48$4.43$4.38$4.33$4.28$4.23$4.18$4.13$4.08$4.03$3.98$3.93$3.88$3.83$3.78$3.73$3.68$3.63$3.58$3.53$3.48$3.43$3.38$3.33$3.28$3.23$3.18$3.13$3.08
$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00
$0.00$250.00$500.00$750.00$1,000.00$1,250.00$1,500.00$1,750.00$2,000.00$2,250.00$2,500.00$2,750.00$3,000.00$3,250.00$3,500.00$3,750.00$4,000.00$4,250.00$4,500.00$4,750.00$5,000.00$5,250.00$5,500.00$5,750.00$6,000.00$6,250.00$6,500.00$6,750.00$7,000.00$7,250.00$7,500.00$7,750.00$8,000.00$8,250.00
$1,000.00$2,250.00$3,750.00$5,500.00$7,500.00$9,750.00$12,250.00$15,000.00$18,000.00$21,250.00$24,750.00$28,500.00$32,500.00$36,750.00$41,250.00$46,000.00$51,000.00$56,250.00$61,750.00$67,500.00$73,500.00$79,750.00$86,250.00$93,000.00$100,000.00$107,250.00$114,750.00$122,500.00$130,500.00$138,750.00$147,250.00$156,000.00$165,000.00$174,250.00
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9-6 (Continued)
1Number
2Buy Price
3Margin
4Loss
5Cumulative
3536373839404142434445
$3.03$2.98$2.93$2.88$2.83$2.78$2.73$2.68$2.63$2.58$2.53
$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00$1,000.00
$8,500.00$8,750.00$9,000.00$9,250.00$9,500.00$9,750.00$10,000.00$10,250.00$10,500.00$10,750.00$11,000.00
$183,750.00$193,500.00$203,500.00$213,750.00$224,250.00$235,000.00$246,000.00$257,250.00$268,750.00$280,500.00$292,500.00
Gross $$2,250.00$11,250.00
% of Equity13%4%
ReturnsAt Turning PointAt All-time Low
Commodity
High
Low
Range
25%
33%
Turning Point
Silver
$11.25
$2.56
$8.69
$4.73
$5.46
$4.235
Silver Contract SpecificationSymbol:Exchange:Trading Hours:Unit:Tick Size:Contract Months:Last Trading Day:
SICOMEX8:25 A.M. to 2:25 P.M. EST (open outcry, Globex after hours)5000 troy oz1⁄2 cent/troy oz or $25.00Jan. (F), Mar. (H), May (K), June (M), Sept. (U), Dec. (Z)Close of business, third last trading day of the maturing month.
Even with its high margin, the silver scale did not do toobadly—a 13 percent return, at the turning point. But if held until anew low is put in, the return drops to only 4 percent. Again, do not
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let that projection scare you out of trading silver. It is extremelyvolatile. You will get many oscillating profits. Fundamentally it hasa strong underbelly, with the electrical, photographic, and jewelryindustries supporting it. These are large and diverse industries. Ifit gets too cheap, the hoarders of Asia will take tons off the market.The scales studied so far are simple scales used for budgeting.By keeping them stripped down to the minimum and on an electronic spreadsheet, it is easy to play what-if games. What if thescale was changed to 5 down, 5 up instead of 5 down, 8 up? Howwould returns be impacted? How about changing the entry point,up or down?It often pays to be conservative at the beginning and becomemore aggressive once the scale begins to take shape. For example,you start the scale with a set interval between buys and sells. As youbegin to approach a trade level where there is strong support on thedownside or resistance on the upside, you reduce the size of the buyand-sell interval. Let’s say the initial scale was to buy every nickeldown and sell every dime up. You might adjust it to buy every 4cents down and sell every 4 cents up for a short period of time.This strategy is designed to take advantage of trading zoneswhere you have good reason to expect volatility to increase.Therefore, you capture more oscillating profits, which substantiallyimproves your return. Areas where there is strong support forfalling prices or resistance to increasing prices are easy to spot oncommodity price charts. You find them by looking back to whathappened the last few times the commodity traded at these prices.Was there congestion? Did the commodity have difficulty movingthrough these price levels? These are called red zones and will bediscussed in detail in the next chapter.Also draw trend lines showing long-term uptrends. As a commodity moves lower and approaches a long-term uptrend that hasbeen out of reach for quite a while, the price of the commodity mustpenetrate the trend line to move lower. These areas often cause anincrease in volatility, meaning oscillating profit opportunities. Theseare signals to adjust your scale to profit from the rocky road ahead.Always keep in mind that the price patterns you see on thecharts are nothing more than a reflection of human nature. No oneknows how low a commodity price will go. On the other hand, noone wants to be left out when it happens. Most speculators are
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opportunists living on a diet of fear and greed. To be successful, theymust act on the anticipation of what is about to happen, not on whathas already happened. When they do, there are others who follow.The second group mimics the first. If the call is correct, everyone—even the commercial and professional traders—stampedes with theherd. If wrong, the speculators close their long positions and themarket falls further of its own weight.All this activity just gives you a chance to make a little moremoney. Once the volatility subsides, you resume your normal scale.Always keep an eye on the daily volume during these periods. Thehigher it is, the greater the volatility as a general rule. Once itbegins to return to a more normal range, you know it is time toresume using your standard trading patterns.The simple or budgeting scales shown so far in this chapterare fine as far as they go. But once you begin to trade