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The Principles Behind Commodex

The Commodex logic is generally well known, simple, and accepted. There are four basic assumptions behind the series of Commodex formulas:

  • Price Up, Volume Up, Open Interest Up – Continued uptrend based upon new “accumulation” of long open interest. Buyers continue to be willing to buy on ever increasing prices. The investing public has confidence prices will continue higher. Sellers will only sell if bid higher prices.
  • Price Up, Volume Down, Open Interest Down – Possible dip or reversal of downtrend based upon “distribution” of long open interest. Here, fewer buyers are willing to buy on climbing prices; they are losing faith that higher levels will be achieved. Buyers are taking profits. The market is losing momentum.
  • Price Down, Volume Up, Open Interest Up – Continued downtrend based upon accumulation of short open interest. Sellers continue to sell despite lower prices. Buyers will only buy if offered decreasing prices.
  • Price Down, Volume Down, Open Interest Down – Possible rally or reversal of downtrend based upon distribution of short open interest. Sellers are no longer willing to sell even though prices are falling. They are losing interest in the short side. Momentum is decreasing as indicated by falling volume and lower open interest.

Commodex uniquely reduces these theories into precise mathematical comparisons.

Price relative to a short term historical perspective;

Price relative to a long term historical perspective;

Change in price relative to changing volume;

Change in price relative to changing open interest.

The maximum index values are +10 for strong long side accumulation and -10 for strong short side accumulation. The scale is as follows:







This is known as the Commodex Daily Index because it measures market action for each day.

In addition to the Daily Index, Commodex computes an “on-balance” composite of “dailies” called the Trend Index. The Trend Index measures accumulations and distributions of Daily Index numbers over a statistically significant period. The maximum Trend Index values are -100 for strongly oversold and +100 for highly overbought.

The Trend Index operates as both an oscillator and an overbought/oversold indicator. When the Trend Index changes speed, it indicates a change in market momentum. A change in direction indicates a change in trend.

Very high or very low Trend Index values take place after long periods of buying or selling. Under such conditions, markets become top-heavy or bottom-heavy. This is particularly true as contracts approach expiration. The “liquidation window” closes as time to expiration decreases.

You receive a complete instruction guide with your subscription.

Understanding the "System Trading" Routine

Trading with Options

Commodex was developed before the creation of exchange-traded commodity options. However, principles governing options price movements are substantially similar to underlying futures contracts. It is important to understand the differences between options and futures before trading.

Briefly, a commodity futures contract is a commitment between two parties to exchange a specific type, quantity, and quality of commodity at a specific date in the future. The commodity may be agricultural like wheat, corn, or cattle. There are also financial futures like treasury bonds, currencies, and stock indices. All futures contracts operate similarly with the recent exception that some are delivered in a "cash equivalent." A cash delivery simply means that the seller gives the buyer the cash value of the contract upon expiration rather then the actual commodity.

Futures contracts are obligations to take or make delivery of the commodity or financial product. On the expiration date, remaining open contracts must be satisfied by delivery. This is the primary difference between futures and their related options.

An option on a futures contract represents the right, but not the obligation, to buy or sell at a specific price called the "strike." As with futures, an option buyer goes "long" while sellers go "short." If the option is the right to buy, it is a "call." The right to sell is called a "put." When you buy options you pay a "premium." This premium is based upon the perceived likelihood that your strike will be reached within the time your option is open. Premium values change with market perception. Generally, traders refer to two factors that influence premium values. The first is "volatility," which is the degree to which prices move within short periods. The second is "time value" and relates to the period before expiration. The longer the time period, the greater the premium. The greater the volatility, the greater the premium.

Any strategy to buy or sell put and call options is fundamentally based in a forecast for price movement. Obviously, you might buy a call option if you believe prices will rise beyond the strike before expiration. A put would be bought if you thought prices would fall below the strike before expiration. On the other hand, you could sell a call if you believe prices will not move higher within the time before expiration. You can sell a put if you believe prices will remain above the strike before expiration.

A major consideration when buying options is your financial exposure. Once purchased, your loss is limited to the premium paid. With futures, losses can only be limited by the use of stops. Stops are not always effective in fast-moving or illiquid markets. If you sell options, your exposure becomes unlimited. However, you collect premium up front.

When Commodex issues a buy signal, the assumed transaction is to purchase the futures contract… to "go long." However, options expand your potential strategy because you can rely upon the same signal to buy a call option, sell a put option, or do both. The same set of choices exists in the opposite direction. When Commodex generates a sell signal for the futures contract, you might buy a put, sell a call, or do both.

Another interesting expansion of your profit opportunities exists when Commodex remains neutral. Prior to options, neutral signals translated into no action and no profit potential. However, if you assume prices for the underlying futures contract will remain stable while Commodex is neutral, you can sell call and put options to collect premiums from both. Clearly, only one side of this double transaction can ever lose because if the call goes beyond the strike, the put will expire worthless and vise-versa. This gives you an increasingly popular approach to using futures in conjunction with options.

Advanced Techniques

Once familiar with options, there are several more advanced applications using Commodex. For example, puts and calls may be substituted for stop protection. If you enter a long position based upon a Commodex buy signal and the stop is too far away, you might consider a put to limit your downside exposure if the premium is affordable. The opposite transaction using a call would apply to a short position.

The Commodex TREND INDEX operates as a highly accurate "overbought" and "oversold" oscillator. This implies that a high positive index value warns of a possible downside correction. If you are holding a long position and the TREND INDEX climbs to a high level of +60 or more, you might sell a call above the market against your open futures position. This is called a "covered write" because you are protected against a breakout above the option strike by your long futures position. If the market continues higher, you still collect your premium. However, your profit on the futures position will be limited or "capped" at the strike price. This same strategy works in the opposite direction for short positions and INDEX values below -60.

In major bull or bear moves, you might use "rolling" calls or puts to protect profits or as a premium collection strategy. In August of 1990, energy prices soared in response to Iraq’s invasion of Kuwait. Call option premiums rocketed to incredible levels. When prices reached toward $40 per barrel, the Commodex TREND INDEX numbers began to indicate an overbought condition. By selling calls, some traders were able to collect huge premiums which appeared to be distorted in value. When prices failed to climb, these huge premiums evaporated leaving the sellers with considerable gains. As the futures prices eventually retreated, call option premiums remained high in fear that the bull trend would rapidly and powerfully resume. By "rolling" the sale of call options down with declining futures prices, a trader could have actually made more money than if he (or she) had been only short futures contracts.

Nimble traders can frequently take advantage of extreme volatility and high premium values as long as they have a good foundation for making their trading decisions. That’s why the Commodex buy, sell, or neutral signal is so important. Commodex provides the "reference" point from which you can plan and implement sophisticated money-making strategies.

coffee commodity

There are many intricate aspects to options valuation and trading. Strategies like long or short "strangles" and "straddles" can compliment your trading program. There are "butterfly spreads" and "condors." For more comprehensive knowledge about options, it is wise to research and read more on the subject. Your local bookstore is likely to carry several excellent introductory and advanced books on the subject. In the meantime, you can use Commodex to investigate and test strategies using options on paper. Once you are comfortable with your "paper trading" program, you can move to actual trading.

Diversification and Portfolio Design

The concept of diversification is not new to portfolio design. In stocks, bonds, and even real estate there is a general rule that diversification helps reduce risk and increase profit potential. In theory, diversification spreads your exposure among financial vehicles that have different risks and respond to different factors. For example, you might invest in commercial and residential real estate to diversify between properties that may respond to the business cycle or to consumer sentiments. Within commercial and residential real estate you can break down diversification between property types like office buildings, strip malls, retail space, town houses, apartments, individual homes, entire developments, etc.

Stock investors usually refer to “industry sectors” with gross categories like transportation, utilities, industrials, and services. These are further refined into “sector groups” like medical, computers, aviation, rail, gold mining, automotive, retail, publishing, and more. Within these groups, you can diversify into drugs, hospitals, medical devices, and alternative care for “medical.” You may break out software, hardware, internet, communications, and maintenance for the “computer” sector group.

For interest rate instruments like bonds, notes, and bills we separate by maturity, yield, commercial issues, and government paper. Within certain groups are particular types of instruments like “zero coupon” and even the “backing” behind the paper will be different.

Commodities and related options also have various degrees of diversification. Like stocks, there are specific sectors. The most generally followed are:



International Softs


Interest Rates


Stock Indices

Price Indices


Within these sectors, there are specific “groups.” Here are the most common groups associated with sectors in the U.S. markets:

Agricultural – Grains, Meats, Foods

Metals – Copper, Silver, Gold, Platinum, Palladium

Energy – Crude oil, heating oil, gasoline, natural gas

International Softs – Sugar, Coffee, Cocoa

Industrials – Lumber, Cotton

Interest Rates – Bonds, Notes, Bills

Currencies – Foreign Exchange and Dollar Index

Stock Indices – S & P 500, mini S & P, NY Index, Value Index, Nikkei, Dow Jones, Mini Russell 2000, NASDAQ

wheat commodity

You should notice that some “groups” represent individual commodities while others can be broken down into group members. Grains encompass wheat, corn, oats, canola, rice, soybeans, and soybean products. Meats cover live cattle, feeder cattle, lean hogs, and pork bellies. Interest rates include 90-day bills, 2-year notes, 5-year notes, 10-year notes, 30-year bonds, and municipal bonds. Foreign exchange incorporates British Pounds, Japanese Yen, Deutschmarks, French Francs, Australian Dollars, Canadian Dollars, Mexican Pesos, and Swiss Francs. (This may change with the introduction of the “Euro”)

Finally, there is diversification over time. For agricultural commodities, different delivery months represent important diversification because some contracts are base upon “old crops” left from a previous harvest while others reflect “new crops” yet to be harvested. “Spread” transactions are frequently based upon the supply and demand differences between old and new crops. For interest rates and currencies, time diversification allows traders to extend transactions over long periods or take advantage of seasonal differentials brought about by the end of fiscal years or holiday seasons.

In stocks, diversification is associated with a negative correlation between issues. The objective is to reduce risk and exposure by buying stocks that are less likely to move in tandem. If steel makers are not positively correlated with food processors, it is wise to buy each so that adversity in one will not necessarily impact the other. However, if steel is positively correlated with auto manufacturing, you would own one or the other, but not both. In theory, you avoid the risk that both stocks will be negatively affected by the same economic conditions.

In futures and options trading the logic is similar. The greater your diversification, the lower the overall risk. However, since futures and options provide profit opportunities in up and down markets with equal ease, the basis for diversifying is different than for stocks or other investments. The objective when trading futures and options is to be in the right markets at the right time… in the right posture. Clearly, not all futures markets are will trend at the same time. When prices are stable, opportunities are slack. When you are dealing with raw materials or flat interest rates, you cannot expect substantial price movement. This suggests that your objective when selecting a commodity or options portfolio is to pick diverse complexes to assure being in one or more trending markets at the correct moment.

You should keep in mind the fact that negative or positive correlation between commodities is not as important as the effectiveness of your trading strategy. Yes, corn and soybeans may move together. Buying or selling both may over weight your portfolio with positively correlated grains that can be affected by rain, exports, etc. Yet, if your strategy is able to accurately forecast both markets, the positive correlation has less significance than a similar pair of stocks. With stocks, the portfolio assumption is that you are always “long” (a buyer) looking for price appreciation.

Commodities offer several levels of diversification that can accommodate capital from as little as $5,000 to several million. A small account might start a program following one grain, one metal, one meat, and one currency. As capital grows (hopefully), an interest rate, soft commodity, and energy contract can be added. Once all sectors are represented by at least one commodity, you can move to the next diversification level with multiple commodities within each sector. Finally, you can trade multiple contract expirations for each commodity.

This simple approach provides a stepladder for growing your commodity trading program while managing risk through diversification. The COMMODEX System tracks 47 U.S. commodities with as many as 100 contract months. This permits trading with small capital or very large capital. COMMODEX is organized by complex and commodity to make the selection easy and fast. A complete explanation of portfolio design and money management comes with the COMMODEX Commodity Trading Kit which is part of the subscription service.

Selecting Your Broker

One of your more important decisions when trading futures and related options is the broker you will use. Some time ago, choices were limited by fixed exchange margins and commission rates. All brokers were required to adhere to the same schedule of fees and margins established by the exchanges. When fees were deregulated, investors were treated to a wide range of services. Today, you can trade through a discount broker, use “full service,” or even place orders electronically through the Internet.

Your decision concerning brokerage is extremely important because your profit performance can be affected. Commission rates can be as low as $15 per round-turn at a deep discount broker if you maintain a high trading activity and healthy account balances. More common discount rates range from $25 to $40. Full service commissions usually begin around $40 and can be as high as $125. A “round-turn” commission refers to a completed transaction; into and out of the market. Some brokers may charge you on a “half-turn.” For options, some brokers may charge the full commission when you enter your trade and nothing when you exit.

While logic dictates that “you get what you pay for,” this is not always the case when seeking brokerage services. Some discount firms provide excellent support. Some “full service” companies can be disappointments. The criteria for selecting whether to use discount or full service depends upon the support you need and the service you desire. Some traders want nothing more than an order desk… no comments, opinions, or information. This is ideal for using a discount firm. Moreover, the greater the discount, the better.

On the other hand, you may want help in placing your order or understanding market conditions. You may seek an opinion or an explanation of how to use stops and limits. In such a case, full service can make more sense. Regardless of whether you use discount, full service, or something in-between, you want an efficient firm that will provide good execution performance. Because commodity and option prices can move very quickly, your executions or “fills” can vary from minute to minute or from one broker to another. This is because different brokerage firms may use different order processing routines.

You may be familiar with the term, “at the floor.” This refers to placing orders directly with floor traders. This is usually considered the most time-efficient method of entering trades. However, the floor is usually a very busy place. It is not likely that you will be allowed to chat if you are truly “going to the floor.” Most brokerage firms have an “order desk.” This is a department of experienced trading clerks or brokers who receive your orders and call them to their floor brokers. This is normally considered the second most time-efficient way to trade. Again, trading desks are very busy and don’t usually have time to discuss your trade. When going to the floor or using a trading desk, you should be well organized. Make sure you don’t double-enter a trade or forget to cancel a stop when leaving a market. Neither the floor broker nor the trading desk have time to check for your errors.

The most common association is with a personal broker. This is a relationship where the broker knows you and your trading style. Your broker monitors your account and is familiar with your positions. Certainly, you must remain well organized and avoid errors even if you have a personal and responsible broker. However, your broker can frequently catch possible problems and he or she clearly has an incentive to help you trader better to continue earning commissions. Your personal broker takes your orders and calls them to the floor or sends them through his own desk for execution.

If you use a personal broker, you are likely to pay a higher commission. Of course, if you have a large account with high volume, your rates may be lowered to near or at discount. The most important criteria when choosing a broker is honesty. It is often a good practice to call the National Futures Association for a background check. Find out if there are any complaints or disciplinary proceedings filed. Determine the nature of any such problems. Be careful in your evaluation of any broker. Keep in mind that a sanction for a bookkeeping error is far less significant than a suspension for a ponzi scheme! If a broker you are considering has a problem on the NFA record, ask the broker for an explanation.

Most brokers are honest and hard working. Therefore, the next criteria is experience. There is no substitute for experience… The longer the better! Experienced brokers are familiar with all types of orders, strategies, and market conditions. They are less likely to panic and more likely to direct you to the right action under most circumstances. Some of the best professionals are those who have multi-level experience. You may have heard the distinction “upstairs” and “downstairs” traders. An upstairs trader is one who works in an office away from the exchange trading floor. A downstairs trader is on or close to the floor.

If you can find a broker who has worked on the floor of the exchange as well as in an “upstairs” environment, it may be helpful. Having floor trading experience gives insight into the way trades are processed and how the “system” works. Obviously, there are many highly qualified brokers who have never worked or even seen the trading floor. Yet, floor experience is simply one more aspect you might look for when selecting the broker or firm where you’ll trade.

Another point to review is the registration status of the brokerage firm. There are several types of brokerage companies including:

Guaranteed Introducing Brokers

Self-Guaranteed Introducing Brokers

Clearing Member Brokers

Non-clearing Member Brokers

Introducing Brokers (IBs) are similar to selling agents for the larger “Futures Commission Merchants” (FCMs). Those IBs that are guaranteed have an exclusive relationship with an FCM that is willing to use its capital to “guarantee” the IB. A self-guaranteed IB must maintain its own minimum capital and can trade with one or more FCMs. While the term “self-guaranteed” may sound less financially secure than guaranteed, these IBs are generally very stable by virtue of their willingness to maintain their own capital base. The National Futures Association (NFA) maintains strict financial requirements for non-guaranteed firms and carefully monitors compliance.

During the financial uncertainty over the October 1987 Crash, it was observed that IBs acted quickly to protect clients against the possibility of failures by the FCM. This was a highly unusual situation, however, it demonstrated that the loyalty of an IB is with its client base. This is not to say that an FCM is any less loyal to its clients. It simply illustrates that an IB can seek to move its clients if the FCM exhibits financial instability or poor performance.

IBs use the facilities of their supporting FCMs. FCMs maintain order desks and relationships with floor brokers. Floor brokers may be independent or can work for the FCM. FCMs may own seats on the exchanges. This affords extra privileges including access to exchange resources and better commission rates for the member firm. (Note: Member firms do not always pass on the lowest rates to customers.) Clearing members are an elite group of FCMs that maintain very large capital deposits with exchange clearing firms. Clearing deposits are used to guarantee transactions in the unlikely event of a default by both the trader and the member firm. The clearing house provides the last line of defense against defaulted transaction through its clearing fund.

When considering a brokerage company, find out the registration status. See how the firm’s standing might affect your trading account. Do you need to go to the floor with your orders? Can you use the trading desk? Do you have a relationship with a retail full-service full-product company? Does it make sense to use a firm specializing in futures? These are important questions.

Commodex trading tends to generate a large number of trades. Therefore, commission expenses are an important consideration. Commodex automatically deducts an average commission of approximately $40 per trade from the PROFIDEX figures. A $10,000 account following a modest Commodex portfolio can experience between four and six trades per month. At $40 per trade, commissions can range between $160 to $240 per month. Over a year, that’s $1,920 to $2,880… 19.2% to 28.8% of the account equity. A $10 difference in commission rate translates into $480 to $720 per year. Therefore, it is easy to see how commissions can impact your trading.

Of course, bad fills can be far worse than higher commissions. Consider that a one-tick differential in treasury bonds represents $31.25. If a broker charges $60 in commission and consistently achieves better treasury bond fills by one or two ticks, it is obvious that you are getting a good deal. A very low rate with bad fills is no bargain!

One of the best rules in commodities is to “know your broker” and make sure your broker knows you. When you fill out your account papers, be as clear and honest as possible. Never exaggerate your financial statistics such as net worth or the amount of risk capital you have. Be very cautious and avoid brokers who suggest being less than truthful on your account forms. Read your forms carefully and ask for an explanation on any item you don’t fully understand. Your decision to trade futures and related options is important. You must enter into a contractual relationship that has many rights and obligations.

Commodity futures markets are exciting and potentially rewarding. A good relationship with your broker will enhance this experience.