Coffee Futures Trading for Beginners

What are Coffee Futures?

Coffee futures are contracts for the delivery of coffee for some date in the future. One coffee futures contract is equal to 37,500 lbs of coffee. This means that for every cent coffee futures fluctuate, either up or down, one contract gains or loses $375. For ever 10 cent fluctuation the futures contract would fluctuate $3,750. Coffee futures have a reputation for being very volatile, so a 10 cent swing in a day or two is quite possible.

Coffee Futures Trading and Minimum and Maintenance Margins

Seeing as how a single coffee futures contract are quite large, and that a single contract is worth the size of the volume of coffee (37,500 lbs) times its current market price, it could cost 50 to 100 thousand dollars to purchase it outright. If the price of coffee is $2.00 even, than we multiply 37,500 times 2 and arrive at a contract value of $75,000. This is a bit pricy even for the best of us, so fortunately we are allowed to purchase a contract on margin, meaning we can pay a small percentage of the contract value, approximately 5 to 10%, and control the price swings on the whole lot.

This is where fortunes are made, as well as poppers. Let’s say that you purchase a futures contract with a minimum margin of $4,000 and the price rises only 10 cents. Then you have nearly doubled your ‘investment’. If on the other hand coffee futures prices fall 10 cents, you can lose 100 percent of your investment or more. Losses and gains in futures trading are infinite. As a precaution, trade houses require you to maintain a minimum maintenance margin so they don’t have to cover your losses. This number is generally based on market volatility, but you can expect them to ask you for more money if you lose more than 30% of your minimum margin. They do this not with kind words and a smile, but by insisting you have sufficient equity in your account to cover price swings, and they draw the money out to cover losses as needed.

Being Long or Short in Coffee Futures Trading

Long and short in futures trading are positions which reflect your assumption on which direction the market will go. If you believe the market will rise, and you consequently purchase a futures contract, then you are long a coffee futures contract. If on the other hand you believe coffee futures are over priced, you have the ability to sell a coffee futures contract (even if you do not own 37,500 lbs of coffee or previously possess a coffee futures contract). If you sell a contract without buying one first, then you are short the market. This reflects your assumption that coffee futures prices will decline, and you’ll profit it they do so. This is a fundamental difference in coffee futures trading versus investing. You do not need to buy value on the cheap and wait until prices rise. You can buy or sell the market, and profit from its movements in either direction.

Coffee Futures Trading and Stop Losses

Profits on the other hand are immediately debited to your account for you to spend before its time, or for you to reinvest in a rising market. Regardless of market direction, it is essential in coffee futures trading (as opposed to futures investing) that you predetermine your risk and place a stop loss. Because coffee futures can rise or fall like lightening, you do not want to ride out a violent swing downward that could cost you 5 to 10 times your initial margin. You should know in advance how much leeway you need to give the market in order for it to prove your speculation true, and if it proves false, allow the market to stop you out.

For those who don’t know what a stop loss is, it is an order for you to sell (or buy) your coffee futures contract should it fall to a certain price. If the market price hits your stop loss price, your contract is immediately sold, taking you out of the market and protecting you from further losses (or potential profits).

Factors Influencing Coffee Futures Trading

Technical Analysis in Coffee Futures Trading

While previous coffee futures prices to not determine futures movements, there are millions of coffee futures traders who spend their lives studying futures price charts, and as a consequence, there are elements of order and predictability within the chaos of day to day price fluctuation. People remember the past. When large numbers of people lost money as prices fell through an important support zone, or made loads of money from a long term breakout, they more often than not try to reproduce those results by playing the game over again when similar price patterns arise. Using technical price indicators will allow you to not so much predict the future based on previous chart formations, but to look for patterns that other coffee futures traders may be looking to capitalize on.

From my experience the best technical indicators for coffee futures trading are:

• Long term trend lines
• The MACD Histogram
• The Relative Strength Index
• Williams %R
• And the 20 day moving average

For crystal clear explanations of these you should read Alexander Elders: ‘Trading for a Living’

Fundamental Analysis in Coffee Futures Trading and the COT Report

Commodity Fundamentals assess the real world supply and demand situation of commodities. In coffee futures trading, this is one of your greatest long term edges, and should always be examined before determining an intermediate or long term position. Coffee is produced in tropical climates all over the world, but there are a few major players who practically determine world supply. These players are Brazil, Vietnam, and Columbia. The coffee futures traded on the ICE exchange are Arabica futures, and these are primarily contributed by Brazil and Columbia. But when there is a deficit in Arabica or Robusta coffee, price spikes in one will generally lead to price spikes in the other.

Knowing the production figures or product forecasts can help you at least be aware of potential shortfalls or surpluses, despite the fact weather plays a large role in crop quality. Unfortunately, for the average trader, these statistics are too detached from day to day market swings, and so are not terribly actionable. But there are trader groups who buy and sell on this information, and they are worth watching, and potentially following.

The three trader groups are commercial traders, or traders who represent companies that buy or sell the physical commodity, large traders, like hedge funds, and small traders, like you and me. Commercial traders in coffee futures trading might be Maxwell House or Duncan Donuts. In the long term, commercial traders tend to be right. In the intermediate term, large traders tend to be right. And in the short term, small traders tend to lose their ass.

If there was ever insider trading in commodities, it occurs by the commercial traders, the ones who have spies and reporters watching crops progress in every country that houses their crop. So being aware of the positions of these traders will greatly enhance your ability to predict trend changes before they occur. When commercial interest is heavily long coffee futures, it would behoove you to work your way into a similar long term position. Their positions are generously tracked at: http://commitmentsoftraders.org/

Seasonality and Coffee Futures Trading

Because coffee is agriculture, and agriculture has seasonal plantings and harvests, there are time of year with an abundance of coffee and a short term lack of supply. This seasonality plays a major role in coffee futures trading. Every May and June Brazil begins to harvest a massive crop. Consequently, every June, or almost every June, coffee futures prices tank sharply to reflect the increase in short term supply. You generally do not want to be long coffee futures in June. A coffee futures seasonality chart can be seen here:  http://www.futuresbuzz.com/seasonal_charts.html

Determining your Coffee Futures Trading Minimum Account Size

Do to the size of a single coffee contract, and the volatility of the market, one should not attempt to trade coffee with less than $20,000, and this may even be too small a sum. A $50,000 account would allow you, with proper money and risk management, to stay the course a while. Most professionals don’t risk more than 2% of their equity on any one trade. On a $50,000 account, that means a $1,000 trade risk, which for coffee, is rarely enough to tell you if you’ve made the right trade. This however depends on which timeline you are trading in. If you are a day trader, you may be able to trade with that small a risk rather well. If you are a position trader, you may need $2,000 to $4,000 dollars of risk per trade.