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How I Teach Coffee Trading

On January 24th, I will be teaching my first “Coffee Trader’s Course” of the new year and I wanted to share a little bit about my philosophy for trading coffee and how I go about teaching. My intention is to share some tips that will be useful to you right now in your coffee trading career, and also to give you some insight into what we will be covering in the course.

In this article, I will start with my number 1 most important skill, give an overview of the foundational skills that I cover in my course, and conclude with some thoughts on price risk management.

My starting point for every course, and the number 1 most important thing that I teach is a little bit controversial.

In fact, when I showed this to a business savvy, (non-trading) family member they recommended that I not advertise this. “Its too touchy feely,” he said. “Talk about profits.” However, all of the successful traders that I know, agreed that this was definitely the proper starting point.

Trader Mindset

The foundation of my course is “Trader Mindset” or more traditionally, “Character”.

This is something that I learned from my time in the Marine Corps. When Marines are sent to bootcamp, they don’t learn the technical skills on fighting wars. To be honest, the army does a better job of teaching combat training in boot camp. What the Marines teach is drill, history, hand to hand combat, resourcefulness and mental toughness. Anyone can learn to shoot a gun or drive a tank, but those technical skills are not the core characteristics of what makes a Marine.

Trading is similar, in that anyone can learn the skills necessary to trade, but not everyone has the #Mindset and mental character required to be a successful trader. However, everyone has the potential to cultivate that Mindset and that is where we start.

Trading successfully requires character above all because there is no single strategy that is the successful way to trade. Successful traders have a mentality. If there was a magic system, you could just buy one of those trading courses that promises to teach you how to trade their winning system using their proprietary software.

Instead, we need to cultivate a mindset of experimentation, honesty, confidence, resilience, and humility. I wish that I could tell you this as the product of all of my trading success, but instead this was a lesson that I learned through successes, failures and learning from successful traders. This concept is echoed by the greats in Schwager’s Market Wizards and the great softs traders like Hank Dunlop, Dave Behrends and Anthony Ward.

In my course, I also provide some actionable ways to turn this “touchy-feely” subject into actionable improvements in your trading. For example, one way of doing this is with systemization of heuristics. Establishing a set of “Trading Rules” is one way to implement these values into your trading.

After Mindset, I go into the core of trading analysis: #fundamentals and #technicals. Many people view these two disciplines as opposites, and they may even identify as one or the other. I’m guilty of this at times. I’ve been known to say, “I was raised a #fundamental #trader”. However, these are just two different angles for looking at price prediction.


Let’s look at Fundamentals first.

Commodity fundamentals is the intersection of #supply and #demand. At its core, fundamental analysis is not that different from the S&D graph they teach in Econ 101. The S&D curve is essentially a #pricemodel, and constructing a price model for #coffee is the culmination of the fundamentals portion of this course.

I show how to make rigorous price models in my class, but the truth is you don’t need fancy spreadsheets to make a price model. Everyone in the coffee market has a mental price model.

The simplest price model might be that coffee tends to fluctuate between $1 and $3 per pound. When supply is extremely tight, prices can hit $3, when supply is plentiful coffee prices tend to languish around $1. Having a mental idea of where Supply and Demand is and applying that on the $1 - $3 scale is a great starting point for understanding what fair value is for coffee.

However, to get to the point of creating a model requires building an S&D balance sheet and that requires understanding the biology of the coffee plant and some basic organizational structure.

Technical Analysis

Technical analysis is often paired with fundamental analysis because it aims to try and find relative value for an asset, but it does so indirectly. Whereas Fundamental analysis tries to take an independent look at the S&D of a commodity with the hope that the crowd will eventually agree with you. Technical analysis looks at the direction and sentiment of the crowd to try and anticipate where its heading.

For me technical analysis is about understanding crowd psychology. In my course I teach about trend following, pattern recognition and systematic trading, but I always start with a picture of Freud. This picture is to remind everyone that we are not trying to come up with magic symbols and secret, pseudo-scientific systems. We are trying to make inferences about crowd #psychology.

The underlying truth that drives technical analysis is that human beings are social animals driven by powerful emotions like fear, greed and the desire to fit in to a group. Technical analysis looks at price action and tries to interpret what sort of crowd psychology generated this price action, and what implications price action will have on crowd psychology.

If there is one piece of advice on technical analysis that I can share from my course that will be useful to you it is this: always think about the “why” of a pattern. Understand the logic of why a particular pattern, or technical study predicts what people say it will predict. If you understand the why, then you will understand the limitations and implications of technical analysis.

Risk Management

The last two days of the course are devoted more explicitly to price risk management. This is a complex process in the coffee markets and it can be even harder if the company teaching you about risk management is also trying to sell you the products that they use to manage risk.

There are plenty of honorable people out there teaching and selling risk management products, but there are also some unscrupulous ones, so you have to be careful. This is one of the advantages I have as an independent educational company. I don’t make money selling financial products so my incentives are aligned with yours.

I teach price risk management from a bottom up and top-down approach.

The bottom-up approach is teaching the basic risk management tools as building blocks and then using those building blocks to build more complex strategies. The core of the building block approach is understanding #derivatives.

A derivative is an asset whose value is “derived” from another asset.

Derivatives got a bad name in the Global Financial Crisis of 2008. On their surface they might seem like a convoluted way to gamble. Why would you want an asset whose value is derived from another asset? The answer is very simple: to manage price risk.

The only way to offset price risk, is with opposite price risk. So price risk management is about constructing a position that allows you to manage which price risk you want to take.

In the course I go pretty deep into #options, #Greeks and #OTC products. These are very complex topics but one of my specialties is to take very dry and complex information and make it fun and digestible. Hence my cartoon ninjas. If you feel like these are topics that you want to get a deeper understanding of without being super boring, I would invite you to join us for the next course.

The top-down approach is where I conclude the course. I teach both, how to think about planning price risk management, as well as a simple strategy that you can use right now to manage your price risk. Thinking about price risk management begins with the ethical component that we discussed in the beginning: Mindset.

The risk management mindset is very similar to the mindset taught to pugilists and warriors around the world. I know that its annoying for crusty old veterans like myself to talk about their glory days in the military, so I try to keep it to a minimum, but the similarity here is real and relevant.

All of us in the coffee business, are managing risk.

This is not a job for the faint of heart. Risk management is by nature a stressful job and that is why we should only engage in it from a position of humility and confidence; from mental strength and flexibility.

In Maclolm Gladwell’s famous popular science book, “Blink: the Power of Thinking without Thinking” he tells the story of Marine Corps General Van Riper. General Van Riper defeated the most expensive war game in history with a vastly outnumber army and inferior set of resources that was designed to lose. But Marines are not trained to lose.

In addition to his Marine Corps training, Van Riper was an expert in asymmetric warfare and was constantly improving the mental toughness and resilience of his troops. As part of this training, he took his officer corps to the NY Mercantile exchange to learn about “digital information bombardment on the battlefield.” In other words, he was training his Marines how to make decisions in a stressful environment. To do that, he had them talk to commodity traders.

Mindset is essential to trading, but its also important for me to give you specifics. So as a system for managing risk that anyone in the coffee supply chain can use right now to manage their risk, I present to you my Systematic Heging (Rule of 3rds) approach.

This strategy involves dividing your hedges into 3 buckets and is based on an important assumption: the average price of the market is your baseline.

The first bucket (1/3 of your hedge) is the neutral hedge or true hedge. Whether you are a buyer or seller of coffee, the average price of the market is what you are trying to beat. If you sell above the average price as a seller of coffee you are winning. If you are a buyer of coffee and you buy below the market, then you are winning. Therefore you can hedge your risk towards neutral (neither winning nor losing) by offsetting some of your position with an average price of the market.

The second bucket (1/3 of your hedge) is the optimistic hedge or conditional hedge. This is a hedge that improves your hedge (buying below, or selling above the market) if you are correct, but worsens your hedge if you are wrong. An example would be placing GTC buy orders as a consumer. If you place buy orders under the market then you buy at a better price if you are directionally correct, but you have to buy at a higher price if you are wrong.

The last bucket (1/3 of your hedge) is the pessimistic hedge or protective hedge. This is a hedge that protects you if the market goes against you but doesn’t provide any upside if the market moves in your favor. An example of this would be a consumer who buys a call. Buying a call will protect you if the market rises but if the market stays flat or declines you will lose money with the premium that you paid.

Finally, these buckets are not static, you adjust the weightings in accordance with your view. Regardless of whether you are an importer, exporter, speculator, roaster or producer, your role in the coffee industry provides you with an edge. Use that edge! Be brave! Be bold! Have a view and use that view to improve your position and manage your risk.

And that, is what I think being a coffee trader is all about.

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