We’ve all heard the lifelong investment motto of diversifying and not putting all your eggs in one basket. But in order to actually apply this strategy, we must analyze it a little further. If we had various baskets (markets) to invest in, how do we determine how many eggs (funds) to deposit in each? If we were to spread out our portfolio evenly across the board, it would be the same as investing in the CCI Index. How do we begin choosing where to weigh more or less on investments?
Depending on the total amount of funds available to invest, you should never risk more than 3-5% on a single trade. Taking this into consideration, you must also evaluate the typical daily price fluctuation in each given commodity, also known as the standard deviation. Now that we know on average how much each commodity fluctuates in one day, we must standardize the movement in dollars. Not all commodities have the same tick value, thus we must calculate how many contracts within various commodities will result in the same fluctuation in relation to your account value.
If we have noticed that Crude Oil on average moves $2/day ($2,000). And we’ve noticed that Corn on average moves 10 cents/day ($500). We would play 1 contact of Crude Oil, against 4 contracts of Corn.
A simpler way to look at this is to evaluate the margin requirements for each particular commodity. The margin requirement already takes into consideration the volatility of the market, and margins are put in place to protect the client from over-leveraging. Taking the example above into consideration, the margin requirement for Crude Oil is $7,100 and the margin requirement for Corn is $2,000. Nearly a 4:1 ratio.
If you were to standardize this method if investing to have an equal weight on each individual trade, you will be able to realize a more balanced profit/loss on each investment. Creating a more systematic methodology towards investing will begin to take the emotion out of trading.
If you have any inquiries about other investment methodologies, please feel free to contact any one of our licensed brokers.
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