How To Trade

**newdigital** · 10-31-2013, 06:46 AM

185. How Futures are Traded Part 2

The next lesson in free online video futures trading course which covers how futures are traded.

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What is Futures Trading?

Futures Trading is a form of investment which involves speculating on the price of a commodity going up or down in the future.

What is a commodity? Most commodities you see and use every day of your life:

the corn in your morning cereal which you have for breakfast,
the lumber that makes your breakfast-table and chairs
the gold on your watch and jewellery,
the cotton that makes your clothes,
the steel which makes your motor car and the crude oil which runs it and takes you to work,
the wheat that makes the bread in your lunchtime sandwiches
the beef and potatoes you eat for lunch,
the currency you use to buy all these things...

... All these commodities (and dozens more) are traded between hundreds-of-thousands of investors, every day, all over the world. They are all trying to make a profit by buying a commodity at a low price and selling at a higher price.

Futures trading is mainly speculative 'paper' investing, i.e. it is rare for the investors to actually hold the physical commodity, just a piece of paper known as a futures contract.

What is a Futures Contract?

To the uninitiated, the term contract can be a little off-putting but it is mainly used because, like a contract, a futures investment has an expiration date. You don't have to hold the contract until it expires. You can cancel it anytime you like. In fact, many short-term traders only hold their contracts for a few hours - or even minutes!

The expiration dates vary between commodities, and you have to choose which contract fits your market objective.

For example, today is June 30th and you think Gold will rise in price until mid-August. The Gold contracts available are February, April, June, August, October and December. As it is the end of June and this contract has already expired, you would probably choose the August or October Gold contract.

The nearer (to expiration) contracts are usually more liquid, i.e. there are more traders trading them. Therefore, prices are more true and less likely to jump from one extreme to the other. But if you thought the price of gold would rise until September, you would choose a further-out contract (October in this case) - a September contract doesn't exist.

Neither is their a limit on the number of contracts you can trade (within reason - there must be enough buyers or sellers to trade with you.) Many larger traders/investment companies/banks, etc. may trade thousands of contracts at a time!

A Short History of Futures Trading

Before Futures Trading came about, any producer of a commodity (e.g. a farmer growing wheat or corn) found himself at the mercy of a dealer when it came to selling his product. The system needed to be legalised in order that a specified amount and quality of product could be traded between producers and dealers at a specified date.

Contracts were drawn up between the two parties specifying a certain amount and quality of a commodity that would be delivered in a particular month...

...Futures trading had begun!

In 1878, a central dealing facility was opened in Chicago, USA where farmers and dealers could deal in ‘spot’ grain, i.e., immediately deliver their wheat crop for a cash settlement. Futures trading evolved as farmers and dealers committed to buying and selling future exchanges of the commodity. For example, a dealer would agree to buy 5,000 bushels of a specified quality of wheat from the farmer in June the following year, for a specified price. The farmer knew how much he would be paid in advance, and the dealer knew his costs.

Until twenty years ago, futures markets consisted of only a few farm products, but now they have been joined by a huge number of tradable ‘commodities’. As well as metals like gold, silver and platinum; livestock like pork bellies and cattle; energies like crude oil and natural gas; foodstuffs like coffee and orange juice; and industrials like lumber and cotton, modern futures markets include a wide range of interest-rate instruments, currencies, stocks and other indices such as the Dow Jones, Nasdaq and S&P 500.

Who Trades Futures?

It didn't take long for businessmen to realise the lucrative investment opportunities available in these markets. They didn't have to buy or sell the ACTUAL commodity (wheat or corn, etc.), just the paper-contract that held the commodity. As long as they exited the contract before the delivery date, the investment would be purely a paper one. This was the start of futures trading speculation and investment, and today, around 97% of futures trading is done by speculators.

There are two main types of Futures trader: 'hedgers' and 'speculators'.

A hedger is a producer of the commodity (e.g. a farmer, an oil company, a mining company) who trades a futures contract to protect himself from future price changes in his product.

For example, if a farmer thinks the price of wheat is going to fall by harvest time, he can sell a futures contract in wheat. (You can enter a trade by selling a futures contract first, and then exit the trade later by buying it.) That way, if the cash price of wheat does fall by harvest time, costing the farmer money, he will make back the cash-loss by profiting on the short-sale of the futures contract. He ‘sold’ at a high price and exited the contract by ‘buying’ at a lower price a few months later, therefore making a profit on the futures trade.

Other hedgers of futures contracts include banks, insurance companies and pension fund companies who use futures to hedge against any fluctuations in the cash price of their products at future dates.

Speculators include independent floor traders and private investors. Usually, they don’t have any connection with the cash commodity and simply try to (a) make a profit buying a futures contract they expect to rise in price or (b) sell a futures contract they expect to fall in price.

In other words, they invest in futures in the same way they might invest in stocks and shares - by buying at a low price and selling at a higher price.

The Advantages of Trading Futures

Trading futures contracts have several advantages over other investments:

1. Futures are highly leveraged investments. To ‘own’ a futures contract an investor only has to put up a small fraction of the value of the contract (usually around 10%) as ‘margin’. In other words, the investor can trade a much larger amount of the commodity than if he bought it outright, so if he has predicted the market movement correctly, his profits will be multiplied (ten-fold on a 10% deposit). This is an excellent return compared to buying a physical commodity like gold bars, coins or mining stocks.

The margin required to hold a futures contract is not a down payment but a form of security bond. If the market goes against the trader's position, he may lose some, all, or possibly more than the margin he has put up. But if the market goes with the trader's position, he makes a profit and he gets his margin back.

For example, say you believe gold in undervalued and you think prices will rise. You have $3000 to invest - enough to purchase:

10 ounces of gold (at $300/ounce),
or 100 shares in a mining company (priced at $30 each),
or enough margin to cover 2 futures contracts. (Each Gold futures contract holds 100 ounces of gold, which is effectively what you 'own' and are speculating with. One-hundred ounces multiplied by three-hundred dollars equals a value of $30,000 per contract. You have enough to cover two contracts and therefore speculate with $60,000 of gold!)

Two months later, gold has rocketed 20%. Your 10 ounces of gold and your company shares would now be worth $3600 - a $600 profit; 20% of $3000. But your futures contracts are now worth a staggering $72,000 - 20% up on $60,000.

Instead of a measly $600 profit, you've made a massive $12,000 profit!

2. Speculating with futures contracts is basically a paper investment. You don’t have to literally store 3 tons of gold in your garden shed, 15,000 litres of orange juice in your driveway, or have 500 live hogs running around your back garden!

The actual commodity being traded in the contract is only exchanged on the rare occasions when delivery of the contract takes place (i.e. between producers and dealers – the 'hedgers' mentioned earlier on). In the case of a speculator (such as yourself), a futures trade is purely a paper transaction and the term 'contract' is only used mainly because of the expiration date being similar to a ‘contract’.

3. An investor can make money more quickly on a futures trade. Firstly, because he is trading with around ten-times as much of the commodity secured with his margin, and secondly, because futures markets tend to move more quickly than cash markets. (Similarly, an investor can lose money more quickly if his judgement is incorrect, although losses can be minimised with Stop-Loss Orders. My trading method specialises in placing stop-loss orders to maximum effect.)

4. Futures trading markets are usually fairer than other markets (like stocks and shares) because it is harder to get ‘inside information’. The open out-cry trading pits -- lots of men in yellow jackets waving their hands in the air shouting "Buy! Buy!" or "Sell! Sell!" -- offers a very public, efficient market place. Also, any official market reports are released at the end of a trading session so everyone has a chance to take them into account before trading begins again the following day.

5. Most futures markets are very liquid, i.e. there are huge amounts of contracts traded every day. This ensures that market orders can be placed very quickly as there are always buyers and sellers of a commodity. For this reason, it is unusual for prices to suddenly jump to a completely different level, especially on the nearer contracts (those which will expire in the next few weeks or months).

6. Commission charges are small compared to other investments and are paid after the position has ended.

Commissions vary widely depending on the level of service given by the broker. Online trading commissions can be as low as $5 per side. Full service brokers who can advise on positions can be around $40-$50 per trade. Managed trading commissions, where a broker controls entering and exiting positions at his discretion, can be up to $200 per trade.

**newdigital** · 11-01-2013, 05:48 AM

188. Trading the E Mini S&P Futures Contract

Why Leverage is the Biggest Advantage and the Biggest Disadvantage

The main advantage and disadvantage in futures trading is the leverage involved. (You can hold a very large amount of a commodity for a small deposit so any gains and losses are multiplied.) This is the main difference between futures trading and, say, speculating with stocks and shares.

For example, you have $3000 to invest. You could buy $3000 of shares in an Oil Mining Company, buying them outright. Or this $3000 may be sufficient margin (a goodwill "security bond") to buy a couple of Crude Oil futures contracts worth $30,000.

The price of Crude Oil drops 10%. If this effects the price of your mining stocks by 10%, you would lose $300 (10% of $3000). But this 10% fall on the value of your Crude Oil futures contracts would lose $3000 (10% of $30,000). In other words, all of your initial stake would be lost trading the futures rather than only 10% of your capital trading the shares.

But, with Stop-Loss Orders you will always know how much money you are risking in any trade.

A Stop Loss Order is a pre-determined exiting point which automatically exits your position should the market go against you. In the above example, you may only decide to risk $1000 on the Crude Oil futures contracts. You would place a stop loss just under the market price and if the market dropped slightly, your position would be exited for the $1000 loss.

So Leverage is great if the market goes in your predicted direction - you could quickly double, treble or quadruple your initial stake. But if the market goes against you, you could lose a lot of money just as quickly. All of your initial stake (your margin) could be wiped out in a few days. And in some cases, you may have to pay more money to your broker if the margin you have put up is less than the loss of your trade.

How to Protect Profits with Stop-Loss Orders

As mentioned above, losses can accumulate just as quickly as profits in futures trading. Nearly every successful trader uses Stop-Loss Orders in his trading to ensure profits are 'locked in' and losses are minimised.

How do Stop-Losses work?

A stop-loss is usually placed when a trade is entered, although it can be entered or moved at any time. It is placed slightly below or above the current market price, depending on whether you are buying or selling.

For example, say Pork Bellies is trading at $55.00 and you think prices are about to rise. You decide to buy one Pork Bellies contract, but you don't want to risk more than $800 on the trade. A one-cent move in the market is worth $4.00 on a pork bellies futures contract so, therefore, you would place your stop at $53.00 (200 cents away from the current price x $4 per point = $800).

You can also move a stop-loss order to protect any profits you accumulate.

Taking the Pork Bellies example: Two weeks later, bellies are now trading at $65.00. You are now up $4000 (1000 cents of movement x $4). To protect these profits, you can raise your stop-loss simply by calling your broker. Say you place it at $63.00, you have locked it a profit of at least $3200 and now risk $800 to your new stop level.

But what if the market went against you? Going back to the original position when you bought at $55.00 with a stop at $53.00: what happens if the market suddenly tumbles down to $51.00 during the day? Your trade would automatically be 'stopped out' at your stop level of $53.00 for an $800 loss. The fact that the market closed the day at $51.00 is irrelevant as you are now out of the market. (Had you not used a stop-loss and viewed the market at the end of the day, you would have large losses on your hands!)

The same would happen if the market reached $65.00 and you had raised your stop to $63.00: If the market fell from here, say to $62.80, you would be stopped out at $63.00 and would have a profit of $3200. Even if the market suddenly reversed here and rose to $79.00, this would be irrelevant as you are now out of the market.

This last example would be annoying because if you hadn't been stopped out, you would now be $9600 in profit. But you were stopped out at your $63.00 stop. The market only went 20-cents under this and reversed!

It is for this reason that some traders don't use stops: they have been stopped out in the past JUST when the market was about to go their way.

The solution is not to abandon using stops as this is EXTREMELY RISKY. The solution is to use stops effectively.

(In fast moving markets it is sometimes impossible for brokers to get your orders exited exactly on your stop loss limits. They are legally required to do their best, but if the price in the trading pit suddenly jumps over your limit, you may be required to settle the difference. In the above scenario, the price of Pork Bellies could open trading at $62.50, fifty cents through your stop at $63.00. Your broker would have to exit your trade here and, in fact, you would lose $1000, $200 more than your anticipated $800.)

Where to Get Market Information

Commodity prices can change direction much faster than other investments, such as company stocks. Therefore, it is important for traders to stay on top of market announcements. Professional traders may use a wide number of techniques to do this, using fundamental information and technical indicators.

Fundamental data may include government reports of weather, crop sizes, livestock numbers, producer’s figures, money supply and interest rates. Other fundamental news that could affect a commodity might be news of an outbreak of war.

Technical indicators are mathematical tools used to plot market prices and behaviour patterns on a graph. These can include trend lines, over-bought and over-sold indicators, moving averages, momentum indicators, Elliott wave analysis and Gann theory.

Some traders use just one of these basic methods religiously, disregarding the other completely. Others use a combination of the two.

Many investors, especially smaller investors, devise their own trading method or purchase one from another trader. (Be careful not to buy a system that has been over-optimised and curve-fitted to fit past data. Many times, I have seen systems claiming 80%+ winning trades on past data, but when I have run the system on current prices, the results are breakeven at best!)

They normally paper trade the method (i.e. they follow the markets but only pretend to place the trades) for a few months to make sure the method works for them before placing any actual trades.

Tracking price charts and keeping up with fundamental data is a difficult full-time job – some large organisations employ dozens of staff to follow market moves. And some traders, especially those on the market floor, may only hold a position for a few hours or even minutes.

So where does this leave the small, independent investor who would like to trade in the lucrative futures markets?

Many trade on a daily or weekly basis, i.e. they note or 'download' market prices at the end of each trading day and make their decisions from this data. Often, they will leave a trade on for at least a few weeks (possibly months). This is a much SAFER way of trading because any fluctuations are ridden out and less panic-buying or selling is involved.

**newdigital** · 11-04-2013, 05:15 AM

190. How to Trade Futures - The Limit Order

The next lesson in our free futures trading course which teaches traders how to trade futures using a limit order.

Futures Contracts for Beginners

If you have a limited amount of capital to invest, you probably can't afford to trade the larger contracts like the Nasdaq and S&P500 as a slight percentage move could be worth thousands of dollars. But there are still plenty of smaller and less expensive contracts you can trade.

All futures contracts have standardised amounts of the commodity which are held by them. For example, if you buy a single pork bellies contract, you are ‘holding’ the value of 40,000lbs of pork bellies. If you sell a single soybeans contract you are betting on the value of 5000 bushels of soybeans.

Each point-move on a particular contract is worth a specific amount, and these amounts vary between contracts. For example, a 1-cent move on a Pork Bellies contract is worth $4, so a move in the market from $60.00 to $61.50 would be worth $600 per contract ($4 x 150 cents). In Soybeans, a 1-cent move in the market is worth $50 so a jump from $500 to $505 is worth $250 ($50 x 5c).

Some contracts are worth a lot more than others, especially if they are trading at historically high prices. For example, at the time of writing, the Nasdaq Index moved up around 10% last month – worth nearly $50,000 per contract! (It is at an all time high, 20 times higher than 10 years ago.) But Wheat dropped around 10% per contract - worth about $1250 per contract. (It is at its lowest price for years.)

Beginners need to first establish if they can afford to trade the commodity - if they have enough margin in their account to cover the trade, and if they can afford a sizeable move against their position. (Some traders such as Larry Williams and Tom Basso feel that risking approximately 3% to 5% of total trading capital on a position is about right. Remember too, that these traders are some of the best in the world - if you are a beginning trader, you should be careful risking that much!) Your broker will probably give you a list of dollar-per-point ratios for all the different contracts, as well as their commission and margin requirements.

A trader also needs to establish the risk/reward of trading on any particular commodity - how much you are risking to your stop loss and how much you intend to win to your target price. (Alternatively, work out the average loss and profit made by your trading system to find the expectancy of a trade's profits.)

It is also important for traders to spread the risk of trading by using different types of commodity. For example, just because you have enough capital to trade 5 contracts, don't buy five energy contracts just because they have the largest risk/reward ratio. Instead, spread your risk by trading some grains, some metal, some energy, some livestock and some currency (if they are potentially rewarding).

You may also buy or sell more than one contract on each commodity to keep the risk balanced. For example, a Pork Bellies contract may be worth a lot more than a Soybeans contract. You may decide to buy two Pork Bellies contracts and six Soybeans contracts to keep the values held on each market about equal.

None of your trades should risk more than 5% of your trading capital if possible. (And in "trading capital", I mean money you can afford to, and are prepared to LOSE!) That way, you would have to lose 20 trades in a row in order to get wiped out.

Futures Trading Alternatives

Speculating on the commodity markets can certainly be an excellent form of investment. But it can require a large amount of capital to speculate effectively on the futures markets. To set up the smallest futures account normally requires at least $5000, and many brokers require proof that you can afford to pay any losses greater than the funds in your account. (In case the market suddenly drops below your stop-loss level.)

Also, even the smallest futures contracts require at least $1000-$3000 in margin for you to hold them. This means a speculator with a $5000 account may only be able to trade one or two markets at a time. Many top traders recommend spreading your risk between several markets at a time. And, as mentioned above, you should only risk up to 5% of your trading capital on any position.

So if you haven't got $20,000 or $100,000 to speculate with, what are your options?

Smaller Futures Contracts

Most of the widely traded futures contracts are large contracts traded on the Chicago Board of Trade, The Chicago Mercantile Exchange or the New York Mercantile Exchange. But there are also other exchanges that trade much smaller futures contracts.

For example, the MIDAM exchange (Mid-America) trades most of the major commodity and currency markets but under smaller contracts. Typically they hold one-fifth to one-half the amount of the commodity of the more popular contracts meaning the risks and margin requirements are a lot less.

Other exchanges around the world trade smaller futures contracts of various commodities, such as Brent Crude Oil on the LPE, London Wheat on LIFFE, and Copper, Aluminium and Tin on the LME.

**newdigital** · 11-07-2013, 09:21 AM

191. Video Futures Trading Course - The Stop Order

How to Protect Profits with Stop-Loss Orders

Losses can accumulate just as quickly as profits in futures trading. Nearly every successful trader uses Stop-Loss Orders in his trading to ensure profits are 'locked in' and losses are minimised.