Riding tigers is exciting and dangerous. When I take a position in the commodity markets near a turning point and then ride the trend I feel like I'm riding a tiger. Every so often, the tiger turns and attempts to bite my head off. If I'm careful it only gets a nip at me. If I'm not, well... it doesn't kill me, but it can hurt my net worth and take me awhile to recover.
When you catch onto a trending commodity market, invariably there come some times when, for whatever reasons, prices take a drastic turn against the trend for one or two days, then recover and continue on the original direction. So, for the speculator who is long, for instance, you buy and watch the price gradually climb, breaking through resistance levels and looking technically strong. You might get lulled into a false sense of security, thinking that you can just sit tight and ride the uptrend for quite some time. If you move your protective stops up (see Using Protective Stops) you might get into a position where you feel that even worst case, you can only exit the position with a gain. Then, it happens, one day the market opens gap down taking out your stops at the least desirable price of the day. So, there you are, stopped out and looking at this huge drop and feeling shaken. Welcome to the tiger.
The drop may wipe out support levels you thought were safe and leave you wondering whether the trend has changed. You might feel relieved to be out with a small profit or small loss. This is the time to climb back onto the tiger, not sit shaken and confused. This happens, and sometimes it happens several times in a trend. After the drop, the market will start moving back up quickly adding to your confusion. The tiger wants you to be confused so that you will make a mistake and he can take advantage. One mistake you could make would be to stay out of the market from that point on. Now, you won't get eaten by that tiger, but you will miss the real profit opportunity of the trend. Another mistake you could make would be to buy back in as the price rebounds back to the area where the drop occurred. The mistake here is that prices might very well drop again (not usually so fast) to test the low again and if you do not have you stop below the previous low, you might get stopped out again. This mistake leads to getting out altogether usually and missing the main opportunity.
Here is the strategy I use to ride the tiger. First, I try to take my initial position as near to the bottom of a downtrend as possible using the strategy outlined in Approaching the Commodity Markets. I set my initial stops below the previous low risking at most $400 on each contract. If the market moves up as I anticipate, I do not move my stops up until the market moves beyond a major long-term resistance level. And then, I give it some room below the resistance level because these drastic counter moves often go beyond major support before turning around. I use the long-term trendline in conjunction with the support level to set my stop. As the market moves up, I add positions using the long-term trendline as my stop points, once again giving prices some room below the trendline in case it breaks the trendline while in free fall.
Then I wait for the drop and add to my position after the fall using the low point of the drop as my stop loss point. This is usually a very good buy point. Often prices will test this point again several weeks later giving you yet another good buy point. This is how I ride the tiger. Once the market has gone through this several times it is ready for the real ride up that we dream about. If you have successfully ridden the tiger and added to your positions rather than being stopped out by the sudden contortions, you will find that the tiger brings great opportunity along with the danger.
The following charts demonstrate the tiger in several markets.I've put in arrows showing the points where you need to go counter to your instincts telling you to jump off this tiger.
The first tiger appears in December 1995 soybean meal in May of 1995. There were good technical reasons for buying one soybean meal contract in May at around 175 and putting in a close stop at 172. The first time the tiger turned was at the end of May. After a steep rise to above 190, it plunged back to around 176 in a matter of three days. This was buy number one on May 29th. It moved back up to near 190 again over the next several weeks only to plunge again back to 175 in two days. This was buy number two on June 26th. It rose again, this time to over 200 before plunging again in two days back to near 175. This was buy number 3 on August 8th. It moved back up to just over 180 and then tested 175 again. This was buy number 4 on August 11th. From there it moved up pretty much without pause to over 230 over the next four months. Those five contracts bought for an average price of 180 would have brought you approximately $25,000 over the seven months you were riding the tiger.
The second tiger appears in December 1995 corn. Corn was a buy early in the year under 250. It moved up strongly May and early June to over 287. Then in a matter of two days dropped to around 260. This was buy number 1 on June 27th. It quickly moved back up above the previous high to over 300. Then over a few day period it dropped back to around 270. This was buy number 2 on August 7th. It moved back up for just a couple of days and then dropped back to 270 again, interday. This was buy number 3 on August 11th. From there it began a strong uptrend that took it to over 340 over the next 4 months. The four contracts bought for an average price of 275 would have brought you approximately $13,000 over a seven month period.
The third example is a tiger in progress as this was written. It appears in March 1996 sugar. This one began with a buy signal in mid September at approximately 10.25. In early January of 1996, the contract was over 12.00, and then in a single day plunged back to around 10.80. This was buy number one on January 16th. Within the next three days the price moved back to approximately 11.50. That is where we are today. I expect that we will see another drop to the 10.80 area for buy number 2 within the next month. If this turns out to be a similar tiger to soybean meal and corn, we could expect to see sugar above 17 within the next 6 months. Time will tell, but for now, I am riding the sugar tiger.
