The concept of intrinsic value does not necessarily apply to other investments. For instance, the stock of today's hot company could actually go to zero due to any number of micro or macro economic circumstances, while a bushel of corn has an intrinsic value virtually assuring that its price will not go to zero.

The what works for the Scale Trading approach is that we can outline our trading plan ahead of time by carefully evaluating current supply/demand statistics and then comparing those with the commodity's historical price range. This gives us the ability to then pinpoint the price at which we want to begin our scale down buying and, most importantly, calculate the total capital we will likely need to maintain that scale under our worst case scenario.

By sticking with "Mother Nature" commodities, particularly those which are grown for human consumption, we ensure that even the worst case scenario will eventually give way to a recovery in prices. While our worst case scenario does not represent a guarantee of what our ultimate exposure will be, the principles that drive the law of supply and demand are the best tools we have found for long term success in the commodity markets.

Scale trading provides the edge and hedged scale trading sharpens that edge, allowing experienced traders to stay on both sides of the market and use their edge most effectively. Understanding Hedged Scale Trading covers everything traders need to know to work with the increased leverage provided by scale trading while covering their backs against the inevitable moments when, despite taking every precaution, they find fast-moving markets moving against them.

Working with the Scale Trading example

What we need, then, is to develop a system that will accomplish this allocation of capital to our strongest and best-performing stocks. As it turns out, we can do this by simply reversing the scale trading approach learned about in the last chapter. So in other words, we add equal dollar amounts to our stock positions as they move up in price, instead of when they move down in price.

Everybody likes to buy a bargain - the opportunity to get something they want before prices get back to “normal.” That’s the premise behind the trading approach known as “scale trading.” Like most methods, scale trading is not a cut-and-dried, easy way to trade. For one thing, you might decide the price is already low and just can’t go any lower. And then it goes lower - much lower, as recent traders in energy, hogs, sugar, copper, soybeans and other markets can attest.

For another thing, even though everyone recognizes the price is unusually low, not enough buyers step in and the market just sits at the low end of its historic range for an extended period of time until buyers give up. In a nutshell, scale trading is for those who are very patient and have very deep pockets. But the current situation is unique and may be the ideal climate for scale trading. Normally, one or two markets may be candidates for scale trading each year, but virtually every commodity has offered scale traders the potential for substantial rewards in the last year. In addition to patience and money, here is the combination you need for scale trading: Physical commodities only - something that is grown or mined and is consumed, therefore subject to supply and demand forces. Historically low prices - you can determine that several ways but basically all you have to do is look at a long-term price chart for the last 20-25 years and divide the price range from low to high in thirds. A market in the lower third is a candidate for scale trading although you may not want to implement such a plan unless prices fall into, say, the bottom 10% of the total range or a more recent range of, say, the last 10-15 years.