The Dynamics of Trading in Commodity Futures

Abstract

We examine weekly trading imbalances for speculators and small investors in the commodity futures market and their price and volatility effects over the period 1986-2012. First, speculators behave like short term momentum traders and long-term contrarians. Their imbalances are positively autocorrelated and positively cross-autocorrelated with small investor imbalances, consistent with their ‘riding the wave’ caused by small traders. Speculators sell (buy) to a greater extent after their long (short) positions have become larger, especially when volatility is elevated: this is consistent with their being risk averse. Small trader imbalances also follow speculator imbalances of a given sign, and display mean reversion and volatility aversion, but both are weaker than for speculators. Second, imbalances have positive and significant permanent price effects, which are larger for speculators. Further analysis suggests that the price impact of speculator imbalances is smaller when they act as suppliers of liquidity to hedgers. Finally, price volatility is related positively to lagged small trader imbalances, supportive of noise trader effects, and negatively to the lagged variability of speculator imbalances, which is inconsistent with speculator activity promoting futures market volatility. Our results are broadly similar in extreme market conditions. The picture that emerges from our analysis is that speculators are risk averse, short-term oriented, liquidity providers with trades that are, in general, not destabilizing. Our work contributes to the debate on the effects of trading, especially by speculators, and the need for new regulatory initiatives.