Commodity Investing and Tax Benefits
With tax season just passed, you may still be hurting from the results. If you requested an extension and haven’t filed yet, this topic might be very helpful to you. Aside from the profit potential that you can realize from trading commodities, there are handsome tax benefits as well. The current tax laws separate investment gains and losses into two expansive groups: short-term capital gains and long-term capital gains. This feature is nice because when you are commodity investing, you are allowed to split your profits between the two categories.
To understand the tax benefits of commodity trading, there are a couple of things to learn. Grab the statements from your commodity account and a calculator, and start a spreadsheet; this is quick and fairly easy to grasp. Here are the things you need to do:
- Understand what short-term capital gains are. Profits from any commodity trade that is held for less than one year are considered short-term capital gains. Short-term capital gains are taxed at the investor’s normal tax rate; if you are in the 25% bracket, your short-term gains will be taxed at 25%.
- Understand what long-term capital gains are. Commodity trades that are held for more than one calendar year are long-term capital gains. Long-term capital gains are taxed at a flat rate of 15% unless you are in the ten percent or fifteen percent brackets and then long-term capital gains are taxed at 5%. For those people who are holding long-term futures contracts, this is obviously a very attractive situation.
- Add up your profits and losses. This is where you can use your calculator (or your computer if you have some spreadsheet skills). For each transaction you made while commodities trading, enter the amount of profit you made as a positive number and the amount of loss you had as a negative number. For example, imagine that you made three commodity trades; you earned $500 on the first, lost $300 on the second and made $1,000 on the third. To calculate your profits, add the numbers together. $500 - $300 + $1,000 = $1,200; $1,200 would be your profit for the year.
- Determine your long-term capital gains. For this calculation, take the total number and multiply it by sixty percent. For our example, $1,200 x 0.60 = $720; this is your long-term capital gains on your commodity investing. Now you need to multiply this number by the 15 percent tax rate; $720 x 0.15 = $108. This will be the long-term capital gains tax responsibility on your commodity long-term investing.
- Determine your short-term capital gains. For this calculation, take the total number and multiply it by forty percent. For our example, $1,200 x 0.40 = $480; this is your short-term capital gains for your commodity investment strategies. Now you need to multiply this number by the 25 percent tax rate (For this example we’ll assume this is your rate but we hope it is higher!); $480 x 0.25 = $120. This becomes your short-term capital gains tax responsibility on your commodity investments.
- Add the two together. Once you add the short and long-term tax numbers together, you have calculated your tax liability for your commodity trading. $108 + $120 = $228.
- Review your savings. In order to see your savings, multiply your total profit for the year by your tax rate and then subtract your actual tax responsibility from this number. (Remember that we assumed you were in the 25% bracket.) $1,200 x 0.25 = $300; this would have been your liability. $300 - $228 = $72. While on the surface this doesn’t seem like a lot but it is actually a 24% reduction in your tax burden for the money you made! 24% can make anyone’s investment philosophy look pretty smart!
Conclusion
Because of the method for computing capital gains, commodity investing can be very beneficial from a tax standpoint. Since futures contracts are taxed at a split rate, 60 percent of your earnings from commodity investments are taxed at the long-term capital gains rate and only 40 percent is taxed at the short-term capital gains rate. This is called the 60/40 tax treatment, and it will save you money in taxes. As always you should consult your tax advisor but you will likely be very pleased with your returns!
Market Direction: When patterns can be identified in the indexes, those same patterns will usually work relatively effectively in individual stocks at the same time. A Jay-hook pattern can be seen forming in the Dow. The simple logic behind a Jay-hook pattern is that if you have a strong uptrend, there is likely to be some profit taking. The Jay-hook pattern allows the candlestick investor to identify whether a pullback is a true reversal or just a profit-taking pullback. The Dow showed some weakness last week and pulled back slightly. However, the T-line, which had been acting as support for the past three months, once again acted as support. Witnessing the Bullish Harami indicated that the selling had stopped. When this occurs on an obvious moving average or support such as a trend line, the probabilities that the support level is going to hold once more is extremely high.
DOW
NASDAQ
When an individual stock price is acting strong in conjunction with a market trend, when that market starts showing some profit taking, it is not unusual to see some profit taking occur at the same time in the individual stock price. This can clearly be seen in the DRYS chart. The Candlestick Forum provides training CDs that demonstrate when the optimal time is for buying into a Jay-hook pattern, where the most likely stop loss level should be placed, what the first target should be and what should be looked for as far as candlestick signals at that level, and finally what the magnitude of the next trend will be if the first resistance level is breached. These are very simple rules for trading well observed and well documented trading patterns. Currently, the Jay-hook pattern in DRYS would confirm a new price trend on a positive open tomorrow. Applying candlestick signals to high probability patterns increases in investor's potential to produce strong returns while at the same time establishing minimal losses.
DRYS
When it can be analyzed that the indexes are moving in a relatively stable trend, whether an uptrend or a downtrend, utilizing candlestick signals and gaps provides very strong profit potential. A candlestick signal has a tremendous amount of information built into it. Most signals illustrate a change of investor sentiment. If that investor sentiment is witnessed to be changing in an overbought or oversold condition, the probabilities of a reversal is that much more likely. If that reversal signal is followed by a gap in price, that also reveals some very important information. A potential change of investor sentiment demonstrated by a candlestick buy signal, followed by a gap up in price not only demonstrates that a change of the trend has occurred but that the new trend has very strong force behind it.
Alaska Air Group Inc. shows a classic reversal at the bottom; a big bearish candle indicating the panic selling at the bottom, followed by two Dojis. The Dojis represent indecision in the oversold area. The gap up the following day demonstrates that the Bulls are now anxious to get back into this price trend.
ALK
This usually foretells of a strong price move. Candlestick signals are merely the results of investor sentiment put into a graphic depiction. Understanding what the investors are doing makes understanding when to buy and when to sell very easy. Click here for the Candlestick Forum Gaps training CD special.
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