Commodity Trading by SelMcKenzie

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 Commodity Trading Author: Dieter Selzer-McKenzie

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Commodity Trading As An Investment Vehicle

There are many inherent advantages of commodity futures as an investment vehicle over other investment alternatives such as savings accounts, stocks, bonds, options, real estate and collectibles.

The primary attraction, of course, is the potential for large profits in a short period of time. The reason that futures trading can be so profitable isleverage.

For instance, if you had a $10,000 futures trading account, you could trade one S&P 500 stock index futures contract. If you were going to buy the equivalent amount of common stocks, you would currently need about $350,000, thirty-five times as much.

Let's say you decided that the stock market was going to go up. You could invest $350,000 and buy individual stocks equivalent to the S&P index, or you could buy one S&P futures contract. Buying a futures contract is the same as betting that the S&P index will go up.

If you had made your move on the first trading day of September, 1996 and held your position for two weeks, your common stock position would have been worth about $20,000 more than when you bought it, a gain of about six percent. Not bad for only two weeks. If you had taken the futures route, however, you would have made the same $20,000, which would have been a 200 percent gain on the $10,000 margin required in your futures trading account.

That is an actual example of the tremendous returns you can earn in a short period of time trading futures. Of course, you can lose money just as fast if you trade in the wrong direction. Suppose you had thought the stock market was about to go down and you had sold a futures contract instead of buying one. If you had valiantly held it for two weeks, you would have lost $20,000. That's a good example of why you must exit your trades quickly if they start to move against you.

Another advantage of futures trading is much lower relative commissions. Your commission on that $20,000 futures trading profit would have been only about $30 to $50. Commissions on individual stocks are typically as much as one percent for both buying and selling. That could have been $7,000 to buy and sell a basket of stocks worth $350,000.

While profits can be large in commodity trading, it is not easy to make consistently correct decisions about what and when to buy and sell.

Commodity speculation offers an important advantage over such illiquid vehicles as real estate and collectibles. The balance in your account is always available. If you maintain sufficient margin, you can even spend your current profit on a trade without closing out the position. With stocks, bonds and real estate, you can't spend your gains until you actually sell the investment.

As you will see, commodity trading is not particularly complicated. Unlike the stock market where there are over ten thousand potential stocks and mutual funds, there are only about forty viable futures markets to trade. Those markets cover the gamut of market sectors, however, so you can diversify throughout all important segments of the world economy.

In futures trading, it is as easy to sell (also referred to as going short) as it is to buy (also referred to as going long). By choosing correctly, you can make money whether prices go up or down. Therefore, trading a diversified portfolio of futures markets offers the opportunity to profit from any potential economic scenario. Regardless of whether we have inflation or deflation, boom or depression, hurricanes, droughts, famines or freezes, there is always the potential for profit trading commodities.

There are even tax advantages to making your money from futures trading. Regardless of the actual holding period, commodity profits are automatically taxed as sixty percent long-term capital gains and forty percent short-term capital gains. The current maximum capital gains rate is thirty-three percent, somewhat less than the maximum rate for ordinary income. To the extent that capital gains tax rates are reduced in the future, commodity traders will benefit. If a distinction is re-established so that taxes on long-term gains are lower than on short-term gains, commodity traders will benefit.

The History of Trading

Although the first recorded instance of futures trading occurred with rice in 17th Century Japan, there is some evidence that there may also have been rice futures traded in China as long as 6,000 years ago.

Futures trading is a natural outgrowth of the problems of maintaining a year-round supply of seasonal products like agricultural crops. In Japan, merchants stored rice in warehouses for future use. In order to raise cash, warehouse holders sold receipts against the stored rice. These were known as "rice tickets." Eventually, such rice tickets became accepted as a kind of general commercial currency. Rules came into being to standardize the trading in rice tickets. These rules were similar to the current rules of American futures trading.

In the United States, futures trading started in the grain markets in the middleof the 19th Century. The Chicago Board of Trade was established in 1848. In the 1870s and 1880s the New York Coffee, Cotton and Produce Exchanges were born. Today there are ten commodity exchanges in the United States. The largest are the Chicago Board of Trade, The Chicago Mercantile Exchange, the New York Mercantile Exchange, the New York Commodity Exchange and the New York Coffee, Sugar and Cocoa Exchange.
Worldwide there are major futures trading exchanges in over twenty countries including Canada, England, France, Singapore, Japan, Australia and New Zealand. The products traded range from agricultural staples like Corn and Wheat to Red Beans and Rubber traded in Japan.

The biggest increase in futures trading activity occurred in the 1970s when futures on financial instruments started trading in Chicago. Foreign currencies such as the Swiss Franc and the Japanese Yen were first. Also popular were interest rate instruments such as United States Treasury Bonds and T-Bills. In the 1980s futures began trading on stock market indexes such as the S&P 500.

The various exchanges are constantly looking for new products on which to trade futures. Very few of the new markets they try survive and grow into viable trading vehicles. Some examples of less than successful markets attempted in recent years are Tiger Shrimp and Cheddar Cheese.

Futures trading is regulated by an agency of the Department of Agriculture called the Commodity Futures Trading Commission. It regulates the futures exchanges, brokerage firms, money managers and commodity advisors.

The Trading Process

Here are some typical steps in the process of making a commodity trade including the trader's decision-making process and the procedures involved in actually placing the trade.

In order to make decisions about when to trade commodity futures, you must have a source of price data. Many daily newspapers carry some commodity prices in their financial sections. The Wall Street Journalhas comprehensive commodity price listings. Investor's Business Daily has both price tables and numerous price charts

All experienced commodity traders prefer to look at price activity on a chart rather than trying to interpret tables of numbers. In financial analysis, charts are indispensable for quickly grasping the essence of historical and recent price action.

The typical commodity chart depicts daily price action as a thin vertical bar which indicates the day's high and low by the top and bottom of the bar. The opening and closing prices are shown as tiny dots attached to the left and right side of the bar. A typical daily price chart can show up to six months of price action this way.

It is easy to change the bar's time frame from days to weeks or months and thus show from two to twenty years of historical price action in the same format. For short-term trading you can change the bar's time frame to hours or even minutes.

Looking at such bar charts enables a trader to see the recent trend of prices--whether up, down or sideways--in whatever time frame he chooses. Following the current trend of prices is a cornerstone of successful trading.

There are a number of ways to obtain the price charts a trader needs to analyze the markets. You can make your own using graph paper. This sounds rather primitive, but some experts recommend it as a good way to put yourself in close touch with price activity and monitor risk.

Another source of charts is the printed chart service. There are about half a dozen of these. They typically mail a booklet of numerous charts covering all the tradeable markets after the markets close on Friday. There is space on the charts to update them daily during the following week until next chart book arrives. These printed chart books normally have a number of indicators plotted along with the price action and contain a wealth of additional information.

For computer owners there are many software programs that create fancy charts on the computer screen. You can input the price data manually or, via telephone modem, download comprehensive data after the markets close for the day. Those with larger budgets can install a small satellite dish and watch price changes in all the markets nearly instantaneously as they occur. The software creates charts dynamically on the computer screen as each trade takes place on the exchanges. You can put many different charts on the screen and thus watch numerous markets all around the world in real time. The cost can range from a few hundred to $1,000 a month depending on the software and the number of exchanges you subscribe to.

It is easy to believe that computers can make a big difference in trading success. Vendors of expensive software will tell you that since other traders, who are your competition, have expensive computer setups, you need one too. This isn't really true.

Those who can't trade profitably without a computer probably won't be helped too much by using a computer. It may actually be detrimental by causing an increase in trading frequency. While a computer will not make a bad trader into good one, they are fun to use, and they do make a trader's life easier.

There are two primary analytic methods for deciding when to take a futures position: fundamental analysis and technical analysis. Fundamental analysis involves using economic data relating to supply and demand to forecast likely future price action. Technical analysis involves analyzing past price action of the market itself to forecast the likely future price action.

While there are differences of opinion about the relative merits of the two approaches, almost all successful traders emphasize technical analysis. There are a number of reasons for this. First and foremost is the difficulty of obtaining accurate fundamental data. While various governments and private companies publish statistics concerning crop sizes and demand levels, these numbers are gross estimates at best. With the current global marketplace, even if you could obtain accurate current information, it would still be impossible to predict future supply and demand with enough accuracy to make commodity trading decisions.

Technical analysts argue that since the most knowledgeable commercial participants are actively trading in the markets, the current price trend is the most accurate assessment of future supply and demand. If someone is correct that for fundamental reasons, prices will likely move up strongly in the future, the commercial participants who have the greatest knowledge and influence on the markets should certainly be moving the price upward right now. If price instead is moving down, a lot of very knowledgeable people must think price in the future will likely be down, not up.

For this reason, almost all successful speculators learn to follow price action and not try futilely to predict turning points in advance. They seek to trade in tune with the large participants who move the markets.

In his classic book, Technical Analysis of the Futures Markets, famous analyst John Murphy summarizes the rationale for technical analysis: "The technician believes that anything that can possibly affect the market price of a commodity futures contract--fundamental, political, psychological or otherwise--is actually reflected in the price of that commodity. It follows, therefore, that a study of price action is all that is required. By studying price charts and supporting technical indicators, the technician lets the market tell him which way it is most likely to go. The chartist knows there are reasons why markets go up and down. He just doesn't believe that knowing what those reasons are is necessary."

Making A Trade

Assuming the trader has consulted his price charts, applied his trading plan's decision-making criteria and decided to make a trade, how does this actually take place? He will have a trading account open with a broker. Believing, for example, that the price of Silver will be going up in the near future, he calls his broker's trading desk, and the following conversation might occur.

The broker may enter the order into a computer or she may call the exchange floor directly. In either case, the order goes to the exchange trading floor in New York City. Once at the broker's desk on the edge of the trading floor, a runner may take the order to the trading pit to be filled or a clerk may transmit it to the pit by hand signals. In the trading pit, a floor broker executes the order with his fellow floor traders by a combination of shouting and hand signals. The process is then reversed as the trade price is communicated back to the customer.

The second sell order was an instruction to the broker to automatically offset the trade if Silver declined in price by $500. This was a prudent step to limit the loss in case price did not go up as the trader expected. Placing the order with the broker means that the trader will not have to monitor the market constantly to be sure the loss does not get too big if price goes down instead of up. The trader is not guaranteed to limit his loss to exactly $500, but he will usually be able offset his position fairly close to the requested price.

The trader can offset his position any time before the Silver contract expires in December. To the extent Silver's price is more than $5.50 an ounce when he offsets, the trader will profit by $50 for each cent. To the extent Silver's price is less than $5.50 when he offsets, the trader will lose $50 for each cent.

To do the same trade with less dollar risk, the trader could have instructed the broker to place the orders at the Mid America Exchange, where the Silver futures contract is only one-fifth the size of the regular New York contract. That would have yielded profits and losses of $10 for each cent rather than $50.

The Truth About the Commodity Markets

In order to be a successful trader, you must understand the true realities of the markets. You must learn how the professionals make money and what is possible. Most traders come into commodity trading, lose a substantial portion of their capital and then leave trading without ever having a correct perception of what good trading is all about.

For many years college professors have argued that the markets are both random and highly efficient. If this were true, it would be impossible to gain an edge on other investors by having superior knowledge or a superior approach.

Professional traders, who make their living trading rather than studying the markets from afar, have always laughed at these ivory tower theories. A good example is George Soros, who has made billions of dollars from trading and is perhaps the greatest trader of all time. Here is how he responds to these ivory tower academics: "The [random walk] theory is manifestly false--I have disproved it by consistently outperforming the averages over a period of twelve years. Institutions may be well advised to invest in index funds rather than making specific investment decisions, but the reason is to be found in their substandard performance, not in the impossibility of outperforming the averages."

Mathematicians have conclusively shown the financial markets to be what are called non-linear, dynamic systems. Chaos theory is the mathematics of analyzing such non-linear, dynamic systems. The commodity markets are chaotic systems. Such systems can produce random-looking results that are not truly random. Chaos research has proved that the markets are not efficient, and they are not forecastable. Commodity market price movement is highly random with a small trend component.

Most beginning traders assume that the way to make money is to learn how to predict where market prices are going next. As chaos theory suggests, the truth is that the markets are not predictable except in the most general way.

Luckily, as Trader Vic suggests, successful trading does not require effective prediction mechanisms. Good trading involves following trends in a time frame where you can be profitable.

The trend is your edge. If you follow trends with proper risk management methods and good market selection, you will make money in the long run. Good market selection refers to trading in good trending markets generally rather than selecting a particular situation likely to result in an immediate trend.

There are three related hurdles for traders. The first is finding a trading method that actually has a statistical edge. Second is following it with consistency. Third is consistently following the method long enough for the edge to manifest itself on the bottom line.

This statistical edge is what separates speculating from gambling. In fact, effective trading is actually like the gambling casino rather than the gambling customer. Professional trader Peter Brandt explains successful trading in just this way: "A successful commodity trading program must be based on the simple premise that no one really knows what the markets are going to do. We can guess, but we don't know. The best a commodity trader can hope for is an approach which provides a slight edge. Like a gambling casino, the trader must earn his profits by exploiting that edge over an extended series of trades. But on any given trade, like an individual casino bet, the edge is pretty meaningless."

Unsuccessful and frustrated commodity traders want to believe there is an order to the markets. They think prices move in systematic ways that are highly disguised. They hope they can somehow acquire the "secret" to the price system that will give them an advantage. They think successful trading will result from highly effective methods of predicting future price direction. These deluded souls have been falling for crackpot methods and systems since the markets started trading.

Prolific futures trading author Jake Bernstein describes how these desperate traders are victimized: "Futures trading is ultimately very simple. Any attempt to make trading complex is a smokescreen. Yet for self-serving reasons an army of greed-motivated promoters try to make things complicated. Too many market professionals consider it their mission in life to obfuscate. Why? Because in so doing they give the appearance that their efforts are scholarly and important. They create a need for more information, and then they fill it!"

Books on how to trade commodities are famous for showing a few well-chosen examples where a described prediction method previously worked. They never show what would have happened if you had applied the method religiously for many years in numerous markets. Those who have tested these methods have found that in the long run almost all of them don't work. Be wary of any trading method unless you see a detailed demonstration showing that it has worked for at least five to ten years in a variety of different markets using exactly the same rules.

The job of the person who wants to trade commodities rationally and prudently is to ignore the promises of those promoting pie-in-the-sky prediction mechanisms and concentrate on finding and implementing a proven, integrated methodology that follows market trends.

Psychological Pitfalls

Here are some additional psychological pitfalls to avoid. Be wary of depending on others for your success. Most of the people you are likely to trust are probably not effective traders. For instance: brokers, gurus, advisors, friends. There are exceptions, but not many. Depend on others only for clerical help or to support your own decision-making process.

You may acquire trading methods or systems from others or from books, but be sure to test them carefully yourself before trading. Good systems that you can buy come with computer software that allows comprehensive historical testing.

Don't blame others for your failures. This is an easy trap to fall into. No matter what happens, you put yourself into the situation. Therefore, you are responsible for the ultimate result. Until you accept responsibility for everything, you will not be able to change your incorrect behaviors.

Stay long-term oriented. Don't adjust your approach based solely on short-term performance. Through luck, any horrible system can look great, even for relatively long periods of time. Conversely, the best systems have frequent losing periods. If you judge a system by short-term performance, you are likely to reject the best systems that exist.

Most traders have such an ego investment in their trading that they cannot handle losses. Several losses in a row are devastating. This causes them to evaluate trading methods and systems based on very-short-term performance. Don't start trading a system based on only a few trades, and don't lose confidence in one after only a few losses. Evaluate performance based on many trades and multi-year results.

Don't underestimate the psychological difficulty of successful trading. Robert Rotella describes the trauma in The Elements of Successful Trading: "Trading is one of the most stressful endeavors imaginable. Taking losses day after day with a strategy that, just a short while ago was working well, can be a terrible experience. Trading performance can be consistently volatile with good and bad times highly magnified. The market can batter your psyche and gnaw at your soul. These bad experiences will never end as long as you trade. The more successful you are as a trader, the more money you will lose."

Keep trading in correct perspective and as part of a balanced life. Trading is emotionally intensive no matter whether you are doing well or going in the tank. It is easy to let the emotions of the moment lead you into strategic and tactical blunders.

Don't become too elated during successful periods. One of the biggest mistakes traders make is to increase their trading after an especially successful period. This is the worst thing you can do because good periods are invariably followed by awful periods. If you increase your trading just before the awful periods, you will lose money twice as fast as you made it.

Knowing how to increase trading in a growing account is perhaps the most difficult problem for successful traders. Be cautious in adding to your trading. The best times to add are after losses or equity drawdowns.

Don't become too depressed during drawdowns. Trading is a lot like golf. All golfers, regardless of their ability, have cycles of good play and poor play. When a golfer is playing well, he assumes he has found some secret in his swing and will never play poorly again. When he is hitting the ball sideways, he despairs that he will never come out of his slump.

Trading is much the same. When you are making money, you are thinking about how wonderful trading is and how to expand your trading to achieve immense wealth. When you are losing, you often think about giving up trading completely. With a little practice, you can control both emotional extremes. You'll probably never control them completely, but at least don't let elation and despair cause you to make unwarranted changes in your approach.

Other common themes of good traders are self-understanding, balance and self-control. If you can master yourself, you can master the futures markets.

I wish you good trading.

Futures Fundamentals

An Introduction 

A futures contract is a type of derivative instrument, or financial contract, in which two parties agree to transact a set of financial instruments or physical commodities for future delivery at a particular price. If you buy a futures contract, you are basically agreeing to buy something, for a set price, that a seller has not yet produced. But participating in the futures market does not necessarily mean that you will be responsible for receiving or delivering large inventories of physical commodities—remember, buyers and sellers in the futures market primarily enter into futures contracts to hedge risk or speculate rather than exchange physical goods (which is the primary activity of the cash/spot market). That is why futures are used as financial instruments by not only producers and consumers but also speculators.

The consensus in the investment world is that the futures market is a major financial hub, providing an outlet for intense competition among buyers and sellers and, more importantly, providing a center to manage price risks. The futures market is extremely liquid, risky, and complex by nature, but it can be understood if we break down how it functions.

While futures are not for the risk-averse, they are useful for a wide range of people. In this tutorial, you'll learn how the futures market works, who uses futures and why, and which strategies will make you a successful trader on the futures market.

A Brief History

Before the North American futures market originated some 150 years ago, farmers would grow their crops and then bring them to market in the hope of selling their inventory. But without any indication of demand, supply often exceeded what was needed, and unpurchased crops were left to rot in the streets! Conversely, when a given commodity—for instance, wheat—was out of season, the goods made from it became very expensive because the crop was no longer available.

In the mid-19th century, central grain markets were established and a central marketplace was created for farmers to bring their commodities and sell them either for immediate delivery (spot trading) or for forward delivery. The latter contracts—forwards contracts—were the forerunners to today's futures contracts. In fact, this concept saved many a farmer the loss of crops and profits and helped stabilize supply and prices in the off-season.

Today's futures market is a global marketplace for not only agricultural goods, but also currencies and financial instruments such as Treasury bonds and securities (securities futures). It's a diverse meeting place of farmers, exporters, importers, manufacturers, and speculators. Thanks to modern technology, commodities prices are seen throughout the world, so a Kansas farmer can match a bid from a buyer in Europe.

How the Market Works

The futures market is a centralized marketplace for buyers and sellers from around the world who meet and enter into futures contracts. Pricing can be based on an open cry system, or bids and offers can be matched electronically. The futures contract will state the price that will be paid and the date of delivery. But don't worry, as we mentioned earlier, almost all futures contracts end without the actual physical delivery of the commodity. 

What Exactly Is a Futures Contract?

Let's say, for example, that you decide to subscribe to cable TV. As the buyer, you enter into an agreement with the cable company to receive a specific number of cable channels at a certain price every month for the next year. This contract made with the cable company is similar to a futures contract, in that you have agreed to receive a product at a future date, with the price and terms for delivery already set. You have secured your price for now and the next year--even if the price of cable rises during that time. By entering into this agreement with the cable company, you have reduced your risk of higher prices.
That's how the futures market works. Except instead of a cable TV provider, a producer of wheat may be trying to secure a selling price for next season's crop, while a bread maker may be trying to secure a buying price to determine how much bread can be made and at what profit. So the farmer and the bread maker may enter into a futures contract requiring the delivery of 5,000 bushels of grain to the buyer in June at a price of $4 per bushel. By entering into this futures contract, the farmer and the bread maker secure a price that both parties believe will be a fair price in June. It is this contract–-and not the grain per se--that can then be bought and sold in the futures market.

So, a futures contract is an agreement between two parties: a short position, the party who agrees to deliver a commodity, and a long position, the party who agrees to receive a commodity. In the above scenario, the farmer would be the holder of the short position (agreeing to sell) while the bread maker would be the holder of the long (agreeing to buy). (We will talk more about the outlooks of the long and short positions in the section on strategies, but for now it's important to know that every contract involves both positions.)

In every futures contract, everything is specified: the quantity and quality of the commodity, the specific price per unit, and the date and method of delivery. The “price” of a futures contract is represented by the agreed-upon price of the underlying commodity or financial instrument that will be delivered in the future. For example, in the above scenario, the price of the contract is 5,000 bushels of grain at a price of $4 per bushel.

Profit And Loss - Cash Settlement

The profits and losses of a futures depend on the daily movements of the market for that contract and is calculated on a daily basis. For example, say the futures contracts for wheat increases to $5 per bushel the day after the above farmer and bread maker enter into their futures contract of $4 per bushel. The farmer, as the holder of the short position, has lost $1 per bushel because the selling price just increased from the future price at which he is obliged to sell his wheat. The bread maker, as the long position, has profited by $1 per bushel because the price he is obliged to pay is less than what the rest of the market is obliged to pay in the future for wheat.

On the day the change occurs, the farmer's account is debited $5,000 ($1 per bushel X 5,000 bushels) and the bread maker's account is credited by $5,000 ($1 per bushel X 5,000 bushels). As the market moves every day, these kinds of adjustments are made accordingly. Unlike the stock market, futures positions are settled on a daily basis, which means that gains and losses from a day's trading are deducted or credited to a person's account each day. In the stock market, the capital gains or losses from movements in price aren't realized until the investor decides to sell the stock or cover his or her short position.

As the accounts of the parties in futures contracts are adjusted every day, most transactions in the futures market are settled in cash, and the actual physical commodity is bought or sold in the cash market. Prices in the cash and futures market tend to move parallel to one another, and when a futures contract expires, the prices merge into one price. So on the date either party decides to close out their futures position, the contract will be settled. If the contract was settled at $5 per bushel, the farmer would lose $5,000 on the futures contract and the bread maker would have made $5,000 on the contract.

But after the settlement of the futures contract, the bread maker still needs wheat to make bread, so he will in actuality buy his wheat in the cash market (or from a wheat pool) for $5 per bushel (a total of $25,000) because that's the price of wheat in the cash market when he closes out his contract. However, technically, the bread maker's futures profits of $5,000 go towards his purchase, which means he still pays his locked-in price of $4 per bushel ($25,000 - $5,000 = $20,000). The farmer, after also closing out the contract, can sell his wheat on the cash market at $5 per bushel—but, because of his losses from the futures contract with the bread maker, the farmer still actually receives only $4 per bushel. In other words, the farmer's loss in the futures contract is offset by the higher selling price in the cash market--this is referred to as hedging.

Now that you see that a futures contract is really more like a financial position, you can also see that the two parties in the wheat futures contract discussed above could be two speculators rather than a farmer and a bread maker. In such a case, the short speculator would simply have lost $5,000 while the long speculator would have gained that amount. (Neither would have to go to the cash market to buy or sell the commodity after the contract expires.)

Economic Importance of the Futures Market

Because the futures market is both highly active and central to the global marketplace, it's a good source for vital market information and sentiment indicators.

  • Price Discovery - Due to its highly competitive nature, the futures market has become an important economic tool to determine prices, based on today's and tomorrow's estimated amount of supply and demand. Futures market prices depend on a continuous flow of information from around the world and thus require a high amount of transparency. Factors such as weather, war, debt default, refugee displacement, land reclamation, and deforestation can all have a major effect on supply and demand, and hence the present and future price of a commodity. This kind of information and the way people absorb it constantly changes the price of a commodity. This process is known as price discovery.
  • Risk Reduction - Futures markets are also a place for people to reduce risk when making purchases. Risks are reduced because the price is pre-set, therefore letting participants know how much they will need to buy or sell. This helps reduce the ultimate cost to the retail buyer, because with less risk there is less chance of manufacturers jacking up prices to make up for profit losses in the cash market.

The Players

The players in the futures market fall into two categories: hedgers and speculators.

Farmers, manufacturers, importers and exporters can all be hedgers. A hedger buys or sells in the futures market to secure the future price of a commodity intended to be sold at a later date in the cash market. This helps protect against price risks.

The holders of the long position in futures contracts (the buyers of the commodity), are trying to secure as low a price as possible. The short holders of the contract (the sellers of the commodity) will want to secure as high a price as possible. The futures contract, however, provides a definite price certainty for both parties, which reduces the risks associated with price volatility. Hedging by means of futures contracts can also be used as a means to lock in an acceptable price margin between the cost of the raw material and the retail cost of the final product sold.

Let's look at an example:
A silversmith must secure a certain amount of silver in six months time for earrings and bracelets that have already been advertised in an upcoming catalog with specific prices. But what if the price of silver goes up over the next six months? Because the prices of the earrings and bracelets are already set, the extra cost of the silver can't be passed onto the retail buyer, meaning it would be passed onto the silversmith. The silversmith needs to hedge, or minimize her risk against a possible price increase in silver. How?

The silversmith would enter the futures market and purchase a silver contract for settlement in six months time (let's say June) at a price of $5 per ounce. At the end of the six months, the price of silver in the cash market is actually $6 per ounce, so the silversmith benefits from the futures contract and escapes the higher price. Had the price of silver declined in the cash market, the silversmith would, in the end, have been better off without the futures contract. At the same time, however, because the silver market is very volatile, the silver maker was still sheltering himself from risk by entering into the futures contract.

So that's basically what hedging is: the attempt to minimize risk as much as possible by locking in prices for future purchases and sales. Someone going long in a securities future contract now can hedge against rising equity prices in three months. If at the time of the contract's expiration the equity price has risen, the investor's contract can be closed out at the higher price. The opposite could happen as well: a hedger could go short in a contract today to hedge against declining stock prices in the future.

A potato farmer would hedge against lower French fry prices, while a fast food chain would hedge against higher potato prices. A company in need of a loan in six months could hedge against rising interest rates in the future, while a coffee beanery could hedge against rising coffee bean prices next year. 

Other market participants, however, do not aim to minimize risk but rather to benefit from the inherently risky nature of the futures market. These are the speculators, and they aim to profit from the very price change that hedgers are protecting themselves against. Hedgers want to minimize their risk no matter what they're investing in, while speculators want to increase their risk and therefore maximize their profits.

In the futures market, a speculator buying a contract low in order to sell high in the future would most likely be buying that contract from a hedger selling a contract low in anticipation of declining prices in the future.

Unlike the hedger, the speculator does not actually seek to own the commodity in question. Rather, he or she will enter the market seeking profits by offsetting rising and declining prices through the buying and selling of contracts. 

The Hedger Secure a price now to protect against future rising prices Secure a price now to protect against future declining prices
The Speculator Secure a price now in anticipation of rising prices Secure a price now in anticipation of declining prices

In a fast-paced market into which information is continuously being fed, speculators and hedgers bounce off of--and benefit from--each other. The closer it gets to the time of the contract's expiration, the more solid the information entering the market will be regarding the commodity in question. Thus, all can expect a more accurate reflection of supply and demand and the corresponding price.

Regulatory Bodies
The United States' futures market is regulated by the Commodity Futures Trading Commission (CFTC), an independent agency of the U.S. government. The market is also subject to regulation by the National Futures Association (NFA), a self-regulatory body authorized by the U.S. Congress and subject to CFTC supervision.

A broker and/or firm must be registered with the CFTC in order to issue or buy or sell futures contracts. Futures brokers must also be registered with the NFA and the CFTC in order to conduct business. The CFTC has the power to seek criminal prosecution through the Department of Justice in cases of illegal activity, while violations against the NFA's business ethics and code of conduct can permanently bar a company or a person from dealing on the futures exchange. It is imperative for investors wanting to enter the futures market to understand these regulations and make sure that the brokers, traders or companies acting on their behalf are licensed by the CFTC.

In the unfortunate event of conflict or illegal loss, you can look to the NFA for arbitration and appeal to the CFTC for reparations. Know your rights as an investor!

Characteristics of the Futures Market

Given the nature of the futures market, the calculation of profit and loss will be slightly different than on a normal stock exchange. Let's take a look at the main concepts:

In the futures market, margin has a definition distinct from its definition in the stock market, where margin is the use of borrowed money to purchase securities. In the futures market, margin refers to the initial deposit of “good faith” made into an account in order to enter into a futures contract. This margin is referred to as good faith because it is this money that is used to debit any day-to-day losses.

When you open a futures contract, the futures exchange will state a minimum amount of money that you must deposit into your account. This original deposit of money is called the initial margin. When your contract is liquidated, you will be refunded the initial margin plus or minus any gains or losses that occur over the span of the futures contract. In other words, the amount in your margin account changes daily as the market fluctuates in relation to your futures contract. The minimum-level margin is determined by the futures exchange and is usually 5% to 10% of the futures contract. These predetermined initial margin amounts are continuously under review: at times of high market volatility, initial margin requirements can be raised.

The initial margin is the minimum amount required to enter into a new futures contract, but the maintenance margin is the lowest amount an account can reach before needing to be replenished. For example, if your margin account drops to a certain level because of a series of daily losses, brokers are required to make a margin call and request that you make an additional deposit into your account to bring the margin back up to the initial amount.

Let's say that you had to deposit an initial margin of $1,000 on a contract and the maintenance margin level is $500. A series of losses dropped the value of your account to $400. This would then prompt the broker to make a margin call to you, requesting a deposit of at least an additional $600 to bring the account back up to the initial margin level of $1,000.

Word to the wise: when a margin call is made, the funds usually have to be delivered immediately. If they are not, the brokerage can have the right to liquidate your position completely in order to make up for any losses it may have incurred on your behalf.

Leverage: The Double-Edged Sword
In the futures market, leverage refers to having control over large cash amounts of commodities with comparatively small levels of capital. In other words, with a relatively small amount of cash, you can enter into a futures contract that is worth much more than you initially have to pay (deposit into your margin account). It is said that in the futures market, more than any other form of investment, price changes are highly leveraged, meaning a small change in a futures price can translate into a huge gain or loss.

Futures positions are highly leveraged because the initial margins that are set by the exchanges are relatively small compared to the cash value of the contracts in question (which is part of the reason why the futures market is useful but also very risky). The smaller the margin in relation to the cash value of the futures contract, the higher the leverage. So for an initial margin of $5,000, you may be able to enter into a long position in a futures contract for 30,000 pounds of coffee valued at $50,000, which would be considered highly leveraged investments.

You already know that the futures market can be extremely risky, and therefore not for the faint of heart. This should become more obvious once you understand the arithmetic of leverage. Highly leveraged investments can produce two results: great profits or even greater losses.

Due to leverage, if the price of the futures contract moves up even slightly, the profit gain will be large in comparison to the initial margin. However, if the price just inches downwards, that same high leverage will yield huge losses in comparison to the initial margin deposit. For example, say that in anticipation of a rise in stock prices across the board, you buy a futures contract with a margin deposit of $10,000, for an index currently standing at 1300. The value of the contract is worth $250 times the index (e.g. $250 x 1300 = $325,000), meaning that for every point gain or loss, $250 will be gained or lost.

If after a couple of months, the index realized a gain of 5%, this would mean the index gained 65 points to stand at 1365. In terms of money, this would mean that you as an investor earned a profit of $16,250 (65 points x $250); a profit of 62%!

On the other hand, if the index declined 5%, it would result in a monetary loss of $16,250--a huge amount compared to the initial margin deposit made to obtain the contract. This means you still have to pay $6,250 out of your pocket to cover your losses. The fact that a small change of 5% to the index could result in such a large profit or loss to the investor (sometimes even more than the initial investment made) is the risky arithmetic of leverage. Consequently, while the value of a commodity or a financial instrument may not exhibit very much price volatility, the same percentage gains and losses are much more dramatic in futures contracts due to low margins and high leverage.

Pricing and Limits
As we mentioned before, contracts in the futures market are a result of competitive price discovery. Prices are quoted as they would be in the cash market: in dollars and cents or per unit (gold ounces, bushels, barrels, index points, percentages and so on).

Prices on futures contracts, however, have a minimum amount that they can move. These minimums are established by the futures exchanges and are known as “ticks.” For example, the minimum sum that a bushel of grain can move upwards or downwards in a day is a quarter of one U.S. cent. For futures investors, it's important to understand how the minimum price movement for each commodity will affect the size of the contract in question. If you had a grain contract for 3,000 bushels, a minimum of $7.50 (0.25 cents x 3,000) could be gained or lost on that particular contract in one day.

Futures prices also have a price change limit that determines the prices between which the contracts can trade on a daily basis. The price change limit is added to and subtracted from the previous day's close, and the results remain the upper and lower price boundary for the day.

Say that the price change limit on silver per ounce is $0.25. Yesterday, the price per ounce closed at $5. Today's upper price boundary for silver would be $5.25 and the lower boundary would be $4.75. If at any moment during the day the price of futures contracts for silver reaches either boundary, the exchange shuts down all trading of silver futures for the day. The next day, the new boundaries are again calculated by adding and subtracting $0.25 to the previous day's close. Each day the silver ounce could increase or decrease by $0.25 until an equilibrium price is found. Because trading shuts down if prices reach their daily limits, there may be occasions when it is NOT possible to liquidate an existing futures position at will.

The exchange can revise this price limit if it feels it's necessary. It's not uncommon for the exchange to abolish daily price limits in the month that the contract expires (delivery or “spot” month). This is because trading is often volatile during this month, as sellers and buyers try to obtain the best price possible before the expiration of the contract.

In order to avoid any unfair advantages, the CTFC and the futures exchanges impose limits on the total amount of contracts or units of a commodity in which any single person can invest. These are known as position limits and they ensure that no one person can control the market price for a particular commodity.

Strategies for Futures

Essentially, futures contracts try to predict what the value of an index or commodity will be at some date in the future. Speculators in the futures market can use different strategies to take advantage of rising and declining prices. The most common are known as “going long,” “going short” and “spreads.”

Going Long
When an investor goes long—that is, enters a contract by agreeing to buy and receive delivery of the underlying at a set price—it means that he or she is trying to profit from an anticipated future price increase.

For example, let's say that, with an initial margin of $2,000 in June, Joe the speculator buys one September contract of gold at $350 per ounce, for a total of 1,000 ounces or $350,000. By buying in June, Joe is going long, with the expectation that the price of gold will rise by the time the contract expires in September.

By August, the price of gold increases by $2 to $352 per ounce and Joe decides to sell the contract in order to realize a profit. The 1,000 ounce contract would now be worth $352,000 and the profit would be $2,000. Given the very high leverage (remember the initial margin was $2,000), by going long, Joe made a 100% profit!

Of course, the opposite would be true if the price of gold per ounce had fallen by $2. The speculator would have realized a 100% loss. It's also important to remember that throughout the time the contract was held by Joe, the margin may have dropped below the maintenance margin level. He would have thus had to respond to several margin calls, resulting in an even bigger loss or smaller profit.

Going Short
A speculator who goes short—that is, enters into a futures contract by agreeing to sell and deliver the underlying at a set price—is looking to make a profit from declining price levels. By selling high now, the contract can be repurchased in the future at a lower price, thus generating a profit for the speculator.

Let's say that Sara did some research and came to the conclusion that the price of oil was going to decline over the next six months. She could sell a contract today, in November, at the current higher price, and buy it back within the next six months after the price has declined. This strategy is called going short and is used when speculators take advantage of a declining market.

Suppose that, with an initial margin deposit of $3,000, Sara sold one May crude oil contract (one contract is equivalent to 1,000 barrels) at $25 per barrel, for a total value of $25,000.

By March, the price of oil had reached $20 per barrel and Sara felt it was time to cash in on her profits. As such, she bought back the contract which was valued at $20,000. By going short, Sara made a profit of $5,000! But again, if Sara's research had not been thorough, and she had made a different decision, her strategy could have ended in a big loss.

As you can see, going long and going short are positions that basically involve the buying or selling of a contract now in order to take advantage of rising or declining prices in the future. Another common strategy used by futures traders is called “spreads.”

Spreads involve taking advantage of the price difference between two different contracts of the same commodity. Spreading is considered to be one of the most conservative forms of trading in the futures market because it is much safer than the trading of long/short (naked) futures contracts.

There are many different types of spreads, including:

  • Calendar spread – This involves the simultaneous purchase and sale of two futures of the same type, having the same price, but different delivery dates.
  • Inter-Market spread – Here the investor, with contracts of the same month, goes long in one market and short in another market. For example, the investor may take Short June Wheat and Long June Pork Bellies.
  • Inter-Exchange spread – This is any type of spread in which each position is created in different futures exchanges. For example, the investor may create a position in the Chicago Board of Trade (CBOT) and the London International Financial Futures and Options Exchange (LIFFE).

How to Trade

At the risk of repeating ourselves, it's important to note that futures trading is not for everyone. You can invest in the futures market in a number of different ways, but before taking the plunge, you must be sure of the amount of risk you're willing to take. As a futures trader, you should have a solid understanding of how the market and contracts function. You'll also need to determine how much time, attention, and research you can dedicate to the investment. Talk to your broker and ask questions before opening a futures account.

Unlike traditional equity traders, futures traders are advised to only use funds that have been earmarked as pure “risk capital”—the risks really are that high. Once you've made the initial decision to enter the market, the next question should be “How?” Here are three different approaches to consider:

  • Do it yourself - As an investor, you can trade your own account, without the aid or advice of a broker. This involves the most risk because you become responsible for managing funds, ordering trades, maintaining margins, acquiring research, and coming up with your own analysis of how the market will move in relation to the commodity in which you've invested. It requires time and complete attention to the market.
  • Open a managed account - Another way to participate in the market is by opening a managed account, similar to an equity account. Your broker would have the power to trade on your behalf, following conditions agreed upon when the account was opened. This method could lessen your financial risk, because a professional would be making informed decisions on your behalf. However, you would still be responsible for any losses incurred and margin calls. And you'd probably have to pay an extra management fee.
  • Join a commodity pool - A third way to enter the market, and one that offers the smallest risk, is to join a commodity pool. Like a mutual fund, the commodity pool is a group of commodities which can be invested in. No one person has an individual account; funds are combined with others and traded as one. The profits and losses are directly proportionate to the amount of money invested. By entering a commodity pool, you also gain the opportunity to invest in diverse types of commodities. You are also not subject to margin calls. However, it is essential that the pool be managed by a skilled broker, for the risks of the futures market are still present in the commodity pool.


Buying and selling in the futures market can seem risky and complicated. As we've already said, futures trading is not for everyone, but it works for a wide range of people. This tutorial has introduced you to the fundamentals of futures. If you want to know more, talk to your broker.

Let's review the basics:

  • The futures market is a global marketplace, initially created as a place for farmers and merchants to buy and sell commodities for either spot or future delivery. This was done to lessen the risk of both waste and scarcity.
  • Rather than trade in physical commodities, futures markets buy and sell futures contracts, which state the price per unit, type, value, quality and quantity of the commodity in question, as well as the month the contract expires.
  • The players in the futures market are hedgers and speculators. A hedger tries to minimize risk by buying or selling now in an effort to avoid rising or declining prices. Conversely, the speculator will try to profit from the risks by buying or selling now in anticipation of rising or declining prices.
  • The CFTC and the NFA are the regulatory bodies governing and monitoring futures markets in the U.S. It is important to know your rights.
  • Futures accounts are credited or debited daily depending on profits or losses incurred. The futures market is also characterized as being highly leveraged due to its margins; although leverage works as a double-edged sword. It's important to understand the arithmetic of leverage when calculating profit and loss, as well as the minimum price movements and daily price limits at which contracts can trade.
  • “Going long,” “going short,” and “spreads” are the most common strategies used when trading on the futures market.
  • Once you make the decision to trade in commodities, there are several ways to participate in the futures market. All of them involve risk, some more than others. You can trade your own account, have a managed account or join a commodity pool.
The Seven Habits of Highly Effective Futures Traders

My interpretation of Covey's agenda is as follows: 1) Take responsibility for yourself and your life, 2) Act in light of your vision of success in life, 3) Act with proper attention to the correct priorities, 4) Act in a way that maximizes benefits for everyone, 5) Try to understand the other person before putting your point of view across, 6) Exploit the potential for cooperation among the people in your life, 7) Pay attention to maintaining and refining your physical, mental, social and spiritual dimensions.

While there does not appear to be any direct relationship between my commodity trading list and Covey's overall life experience list, there are some definite similarities and differences. It is well known that normally successful approaches do not work in trading. Additionally, life in general requires involvement and interrelating with other people, while trading is a more solitary endeavor. Here is my list of successful habits for traders.

ONE. Understand the true realities of the markets. Understand how money is made and what is possible. The markets are what is called chaotic systems. Chaos theory is the mathematics of analyzing such non-linear, dynamic systems. According to Edgar Peters, author of Chaos and Order in The Capital Markets, mathematicians have conclusively shown the to be non-linear, dynamic systems. Among other things chaotic systems can produce results that look random, but are not. A chaotic market is not efficient, and long-term forecasting is impossible. Market price movement is highly random with a trend component.

Unsuccessful and frustrated commodity traders want to believe there is an order to the markets. They think prices move in systematic ways that are highly disguised. They want to believe they can somehow acquire the "secret" to the price system that will give them an advantage. They think successful trading will result from highly effective methods of predicting future price direction. They have been falling for crackpot methods and systems since the markets started trading.

The truth is that the markets are not predictable except in the most general way. Luckily, successful trading does not require effective prediction mechanisms. Successful trading involves following trends in whatever time frame you choose. The trend is your edge. If you follow trends with proper money management methods and good market selection, you will make money in the long run. Good market selection refers to selecting good trending markets generally rather than selecting a particular situation likely to result in an immediate trend.

There are two related problems for traders. The first is following a good method with enough consistency to have a statistical edge. The second is following the method long enough for the edge to manifest itself.

TWO. Be responsible for your own trading destiny. Analyze your trading behavior. Understand your own motivations. Traders come into commodity trading with a view to making money. After awhile they find the trading process to be fascinating, entertaining and intellectually challenging. Pretty soon the motivation to make money becomes subordinated to the desire to have fun and meet the challenge. The more you trade to have fun and massage your ego, the more likely you are to lose. The kinds of trading behaviors that are the most entertaining are also the least effective. The more you can emphasize making money over having a good time, the more likely it is you will be successful.

Be wary of depending on others for your success. Most of the people you are likely to trust are probably not effective traders. For instance: brokers, gurus, advisors, system vendors, friends. There are exceptions, but not many. Depend on others only for clerical help or to support your own decision-making process.

Don't blame others for your failures. This is an easy trap to fall into. No matter what happens, you put yourself into the situation. Therefore, you are responsible for the ultimate result. Until you accept responsibility for everything, you will not be able to change your incorrect behaviors.

THREE. Trade only with proven methods. Test before you trade. When applied consistently, most trading methods don't work. The conventional wisdom that you read in books is mostly ineffective.

Notice that commodity authors never demonstrate the effectiveness of their methods. The best you can hope for is a few, well-chosen examples. The reasons for this is that they are lazy and their methods mostly do not work when tested rigorously.

You must be skeptical of everything you read. You must somehow acquire the ability to test any trading method you intend to use. The reliability of non-computerized testing is highly suspect. You must, therefore, use software that tests a particular approach or a variety of approaches. You must learn the correct way to test and evaluate trading approaches.

Have a good approach. Follow the four cardinal rules of trading. 1) Trade with the trend. 2) Cut losses short. 3) Let profits run. 4) Manage risk. These are well known cliches. Yet virtually all losing traders violate these rules consistently. Trading with the trend means buying strength and selling weakness. Most traders are more comfortable buying weakness and selling strength, the essence of top and bottom picking.

Trade good markets. Trend is your only edge. You must emphasize those markets which trend the best. This will maximize your statistical edge over time. I wrote a huge book (which I update every year) ranking the markets in historical trendiness.

FOUR. Trade in correct proportion to your capital. Have realistic expectations. Don't overtrade your account. One of the most pernicious roadblocks to success is a manifestation of greed. Commodity trading is attractive precisely because it is possible to make big money in a short period of time. Paradoxically, the more you try to fulfill that expectation, the less likely you are to achieve anything.

The pervasive hype that permeates the industry leads people to believe that they can achieve spectacular returns if only they try hard enough. However, risk is always commensurate with reward. The bigger the return you pursue, the bigger the risk you must take. Even assuming you are using a method that gives you a statistical edge, which almost nobody is, you must still suffer through agonizing drawdowns on your way to eventual success.

The larger the return you attempt, the larger your drawdowns will be. A good rule of thumb is to expect an equity drawdown of about half the percentage of your annual profit expectation. Thus, if you shoot for annual returns of 100 percent, you should be ready for drawdowns of 50 percent of your equity. Almost no one can keep trading their method through 50 percent drawdowns.
It is better to shoot for smaller returns to begin with until you get the hang of staying with your system through the tough periods that everyone encounters. An experienced money management executive has stated that professional money managers should be satisfied with consistent annual returns of 20 percent. If talented professionals should be satisfied with that, what should you be satisfied with? Personally, I believe it is realistic for a good mechanical system diversified in good markets to expect annual returns in the 30-50 percent range. This kind of trading would still result in occasional drawdowns up to 25 percent of equity.

FIVE. Manage risk. Manage the risk of ruin when you create your trading plan or system. Manage the risk of trading when you select a market to trade. Manage the risk of unusual events. Manage the risk of each individual trade.

The risk of ruin is a statistical concept that expresses the probability that a bad run of luck will wipe you out. On average, if you flip a coin 1,024 times, you will have ten heads in a row at least once. Thus, if you are risking ten percent of your account on each trade, chances are you will be completely wiped out before long. If your trading method is 55 percent accurate (and whose is?), you still have a 12 percent chance of being wiped out before doubling your capital if you risk 10 percent of capital per trade. For the mathematicians out there, this assumes that you win or lose the same amount on each trade. That is unrealistic, but I'm just trying to explain the risk of ruin problem. The point is that in order to reduce the harm caused by unavoidable strings of losses, you must keep the amount you risk on each trade to about one or two percent of capital. This makes trading with small accounts difficult. Two percent of $5,000 is only $100. That means with a $5,000, you should be trading with $100 stops. If you trade with $500 stops, your chances of avoiding meltdown from a bad series of trade are not good. Trading with small stops is usually ineffective because they are within the market's "random noise."

Another element of risk is the market you trade. Some markets are more volatile and more risky than others. Some markets are comparatively tame. Some markets, such as currencies, have a greater chance of overnight gaps which increases risk. Some markets have lower liquidity and poorer fills which increases risk. If you have a small account, don't trade big money, wild-swinging contracts like the S&P. Don't be above using the smaller-sized Mid-America contracts to keep risk in proportion to your capital. Don't feel you have to trade any market that might make a move. Emphasize risk control over achieving big profits.

The commodity markets are notorious for making locked-limit moves where the trader is stuck in his losing position. The market can go against him for days while he must helplessly watch his capital disappearing. This is certainly a reality, but the trader is not helpless to decrease the risk of it happening to him. Pay attention to the risk of surprise events such as crop reports, freezes, floods, currency interventions and wars. Most of the time there is some manifestation of the potential. Don't overtrade in markets where these kinds of events are possible.

The most important element of risk control is simply to keep the risk small on each trade. Always use stops. Always have your stop in the market. Never give in to fear or hope when it comes to keeping losses small. Never risk more than one or two percent of capital. Preventing large individual losses is one of the easiest things a trade can do to maximize his chance of long-term success.

SIX. Stay long-term oriented. Don't adjust your approach based solely on short-term performance. Our entire society emphasizes instant gratification. We are consuming are long-term capital. Eventually, this will lead to a decline in our standard of living over what it could have been with more attention to the future.

Most traders have such an ego investment in their trading that they cannot handle losses. Several losses in a row are devastating. This causes them to evaluate trading methods and systems based on very-short-term performance. Statisticians tell us that there is no statistical reliability to a test unless you have 30 events to measure. Short of a reasonable number of events, the outcome is wholly dependent on luck. As we saw in the risk of ruin discussion above, strings of losses are as certain as government inefficiency. Thus, the trader who chucks his system after four losses in a row is doomed to spend his trading career changing from one system to another. Don't start trading a system based on only a few trades, and don't lose confidence in one after only a few losses. Evaluate your performance based on many trades and multi-year results.

SEVEN. Keep trading in correct perspective and as part of a balanced life. Trading is emotionally intensive no matter whether you are doing well or going in the tank. It is easy to let the emotions of the moment lead you into strategic and tactical blunders.

Don't become too elated during successful periods. One of the biggest mistakes traders make is to increase their trading after an especially successful period. This is the worst thing you can do because good periods are invariably followed by awful periods. If you increase your trading just before the awful periods, you will lose money twice as fast as you made it. Knowing how to increase trading in a growing account is perhaps the most difficult problem for successful traders. Be cautious in adding to your trading. The best times to add are after losses or equity drawdowns. Don't become too depressed during drawdowns. Trading is a lot like golf. All golfers, regardless of their ability, have cycles of good play and poor play. When a golfer is playing well, he assumes he has found some secret in his swing and will never play poorly again. When he is hitting it sideways, he despairs he will never coming out of his slump.

Trading is much the same. When you are making money, you are thinking about how wonderful trading is and how to expand your trading to achieve immense wealth. When you are losing, you often think about giving up trading completely. With a little practice, you can control both emotional extremes. You'll probably never control them completely, but at least don't let elation and despair cause you to make unwarranted changes in your approach.

Since correct trading is boring, don't depend on trading as your primary stimulation in life. Unfortunately, the exciting aspects of trading, such as easy analysis and trade selection, are counterproductive. Good trading is repetitive and pretty dull. Thus, if you depend on trading for the major excitement, pursuit of fun will probably cause you to lose. If you can afford it, fine. If not, seek your entertainment elsewhere.

Here's a summary of my seven habits of successful traders. 1) Understand the true realities of the markets. 2) Be responsible for your own trading destiny. 3) Trade only with proven methods. 4) Trade in correct proportion to your capital. 5) Manage risk. 6) Stay long-term oriented. 7) Keep trading in correct perspective and as part of a balanced life. The common theme is self-control. As I've often said, if you can master yourself, you can master the markets

The Correct Way to Optimize Commodity Trading Systems

In previous articles in this space I have made the case that the average person has the best chance to be a profitable trader if he or she adopts a 100-percent mechanical approach. This is the only surefire way to minimize the emotional influences that inevitably destroy nearly every trader. It is also the only way to know whether your method has been profitable historically. Abandon the idea that you will ever find the "perfect" system. The perfect system this month may be lousy next month. It will definitely have many difficult periods in the future. Just as every trader and every methodology has losing periods, every system, no matter how brilliantly created, will encounter periods of market price action it cannot trade successfully. Thus, I am content with a good system. I define a good system as one that has a low enough drawdown and sufficient profitability in hypothetical historical testing to satisfy me as well as being robust enough to trade many markets profitably using the same parameters.

In creating a system, the designer must not fall into the trap of over-curve-fitting the system to back data. The more you bend your system around to improve performance on past data, the less likely it is your system will trade profitably in the future. This is very hard for inexperienced traders to accept. They expect that methods which worked well in the past will probably work well in the future. Past performance will only approximate (and I emphasize approximate) future performance to the extent the system is not over-curve-fitted.

The best way to guard effectively against over-curve-fitting is to make sure your system works in many markets using the same parameters. Successful system traders use the same system parameters for each market no matter how counter-intuitive this seems. If you doubt me, read the two "wizards" books by Jack Schwager. Jack himself manages money using systems that employ the same parameters for each market.

The more markets and the longer the historical time period your system can trade profitably, the more robust it is. I trade one of my systems in fifteen markets using the same parameters for each. It is historically profitable in even more markets over the last ten years.

So long as a system tests well over a large number of markets, there is no requirement that you trade it in all of them to diversify. You could have ten systems that all tested profitably in fifteen markets over the last six years and choose to trade each of them in only one market. That would allow you to trade ten diverse markets using a non-curve-fitted system in each. It would be just as acceptable theoretically as trading one of those systems in the same ten markets.

That principle permits a kind optimization that will allow you trade one system using a different set of optimized parameters for each market. Those who want to optimize each market separately can do so without fear of over-optimizing.

Here is the correct process. Decide which markets you may want to trade. To be safest, you should trade only markets which test profitably using the same set of parameters (the system default parameters perhaps) for at least the last five years. Let's say your system trades twenty markets profitably using the default parameters. That will be your universe for testing.

You may optimize the system on each market individually. Go ahead and knock yourself out trying to maximize the profit and minimize the drawdown in each market. You will probably come up with twenty different parameter sets. Now comes the hard part. Take each one of your twenty optimized parameter sets and use it on the entire universe of twenty markets. See whether the optimized parameters hold up as well as the default parameters in trading all the other markets. If an optimized parameter set trades all twenty markets profitably, you can be confident that you have not over-optimized to the point of curve-fitting. You may use that parameter set to trade the market you have created it for.

If an optimized parameter set has a hard time trading other markets profitably, that is a warning signal you have over-optimized. You should start over with the commodity it was designed for and create another parameter set that does a better job on the rest of the markets.

Whether you require an optimized parameter set to trade all markets profitably that the default parameters do or just a certain percentage of them, is a question of judgment. You may want to use an optimized parameter set that trades profitably most, but not all, the markets in your universe. The more markets you require, however, the greater the chance that your system will work in the future and not just on past data.

While I have described this hyper-optimization process, I am not personally convinced that it is worth the effort. I know of no evidence that suggests such individually optimized parameter sets are likely to be more profitable in the future than an unoptimized single parameter set. If it makes you feel better to show larger hypothetical historical profits, however, it probably won't hurt.

When you are satisfied with the parameter sets for all the markets in your universe, you are ready to create the portfolio you will actually trade. I arrange the markets in order of profitability using the average trade as the benchmark. Then I experiment with different portfolios trying to create one with as much diversification as possible while maintaining a low maximum drawdown in relation to the average annual portfolio profit. The proper starting account size should be equal to or greater than twice the maximum historical portfolio drawdown plus the total portfolio initial margin.

My software allows the portfolio selection process to be expanded even further by testing and including multiple systems in the total trading plan.

Implementing A Mechanical Approach to Trading Commodities

In my article in the last issue of Trader's World, I argued that "The average person has the best chance to be a profitable trader if he or she adopts a 100-percent mechanical approach." This is the only surefire way to minimize the emotional influences that inevitably destroy nearly every trader. I know that in my own case, the more mechanical I am, the better my results are. Assuming you have decided to try the 100-percent mechanical approach, how exactly should you proceed? You would think that the most important step would be to find the perfect system. Strangely, finding the system is only a small part of the job. In the first place, you must abandon the idea that you will ever find the "perfect" system. The perfect system this month may be lousy next month. It will definitely have many difficult periods. A system can only exploit one time frame at a time. (What traders think of as a non-trending market is really a trending market in a shorter time frame.) There is no indicator now, and there never will be one, that can predict what type of market you will have in the future. You can never know which time frame will be optimal to trade in the near future. The best an indicator can do is tell you what type of market you are in now. You should pick a system that has done a good job historically over a long period of time. You hope and expect that if you trade it long enough in the future, you will eventually achieve approximately the same level of profitability.

One key to success is to diversify as much as your capital will allow in markets and (perhaps) time frames. Up to about $50,000 in capital, I suggest you pick a relatively long-term system and use your diversification power to diversify in markets only. One system should be enough, but there is nothing wrong with trading several systems using different markets. If you have more than $50,000, you can begin to think about adding additional systems to diversify into shorter-term time frames.

Long-term trading is the most efficient. In long-term trading, you hold winning trades longer, so your average profit per trade will necessarily be larger than in short-term trading. As your time frame becomes shorter, your holding period becomes shorter and your average profit per trade becomes smaller and smaller. However, your costs of trading (slippage, commissions and the bid/asked spread) stay the same. Thus, your system has less margin for error. A long-term system may give you an average trade of $500 to $2,000. A short-term system may yield an average trade down to $50. If, because of adverse market conditions, your system's efficiency decreases by $500 per trade, your long-term system may still make money, but your short-term system will be in big trouble. [To the extent that you may need intraday quote equipment for very short-term trading, your general overhead increases as well. This may or may not be offset by an increased number of trades creating additional profit.]

The purpose of diversifying into a shorter-term time frame is to smooth out the equity curve by being able to take advantage of periods when the markets are congesting in your long-term time frame. Trading shorter-term can also make better use of capital if your system can move from market to market seeking the best opportunities.

Depending on your trading personality, you may prefer to use additional capital to diversify in long-term systems or just add additional contracts in the markets you are already trading. I believe this approach offers the highest probability of making long-term profits and the highest expected value of profits earned. The key to benefitting from the long-term statistical advantage is to trade a well-selected group of diversified markets and to have the discipline and courage to keep trading your system until you reach the long-term.

Almost all traders fail to exploit the statistical advantage of following trends in the futures markets. They do not trade their system religiously, they choose a poor group of markets to trade or they overtrade their capital and are forced to quit too soon. An essential thing to avoid is trading with an over-curve-fitted system. Nearly every system is curve-fitted to some extent. The minute you test an idea and then change it at all to improve performance, you have engaged in curve-fitting. The more you bend your system around to improve performance on past data, the less likely it is your system will trade profitably in the future. This is very hard for inexperienced traders to accept. They expect that methods which worked well in the past will probably work well in the future. Past performance will only approximate (and I emphasize approximate) future performance to the extent the system is not over-curve-fitted.

The best way I know to guard effectively against over-curve-fitting is to make sure your system works in many markets using the same parameters. Successful system traders use the same system parameters for each market no matter how counter-intuitive this seems. The more markets and the longer the historical time period your system can trade profitably, the more robust it is. But don't expect your system to trade all markets and all time frames profitably. This will not happen. I trade one of my systems in fourteen markets using the same parameters for each. So long as a system tests well over a large number of markets, there is no requirement that you trade it in all of them to diversify. You could have ten systems that all tested profitably in fifteen markets over the last six years and choose to trade each of them in only one market. That would allow you to trade ten diverse markets using a non-curve-fitted system in each. It would be just as acceptable theoretically as trading one of those systems in the same ten markets.

For myself, I am not concerned about finding the perfect system. I want to trade a good system, an adequate system that is not over-curve-fitted. I then spend considerable time choosing a good portfolio of markets to trade.

Day-trading: Not what you think ?

The day-trader is a cross between an extrovert and an introvert with both characteristics in balance.

The introvert aspect is depicted by the disciplined workaholic with a reclusive concentration. The extrovert aspect is depicted by an aggressive, competitive, self-motivated individual striving to be the best in a selective profession.

If you think you have that Dr. Jekyll/Mr. Hyde personality, then you are invited to explore my world -- the world of the professional trader.

I am easy to describe. I have an insane personality that is intermittently interrupted by craziness. Why else would anyone set up a multi-million dollar trading business in a rural surrounding in his great-grandfather's farm house, working five 12-hour days a week as well as a partial six-hour day thrown in on Saturday?

The intermittent craziness occurs when I try to find ways to spend the money. A true test of your success is to make more money than your kids can spend with constant spending influences of a "Honey, can I..." wife -- which always means get out the checkbook.

Why do I do it? It's one of the last bastions of pure capitalism. It gives the same opportunity to a hillbilly farm boy in bib overalls living in East Sparta, Ohio, as it does to an Ivy League university graduate in a tailor-made suit on Wall Street.

Each day I am a creature of habit, going through a daily ritual before the markets open. I outline in detail all three possible scenarios for that day: up, down or sideways. I assign a probability to that scenario and make a written strategy plan, which has been incorporated into a trading fax service that is devoted to teaching people how to trade. Thus, a disciplined trading plan is imposed on me.

Every successful trader must be flexible, alert and feisty. The flexibility must be used to shift from being long to being short literally within seconds. The alertness is used for observing price movements that are an aberration from the norm. Feistiness is the savvy aggressiveness to fight back with a vengeance to regain money you lost. I don't know how many times I've seen people lose money in the morning and quit. My most profitable days are when I lose money in the morning and stay in because I want to get it back.

Once the trading day begins, all of my focus is on my quote screen and three markets: S&P 500 Stock Index futures, 30-year T-bond futures and the S&P 100 Index options (OEX).

All day long I record a diary of the trading patterns for that day. This is a ritual I've done for 12 years, and the diaries have been priceless. Recurring patterns are much more frequent than people realize, and referring to the diaries has reinforced the adage, "If you don't know history, you are doomed to repeat it." The diaries clearly show that trading is actually a composite of many ebbs and flows at different times of the day. They have helped me develop the following set of daily trading rules:

1) Do not trade the last hour of the day in the S&P futures market.

The probabilities of a successful trade diminish in this time frame due to the impulsive and reckless buying and selling by institutions just because they didn't get their trading done earlier.

2) If you don't like the trade you're holding, get out.

This is where my emotions do come to the forefront because I hate to lose. Not liking a trade simply comes from analyzing in my mind that this "hated" position has more probability to separate me from my objective of making money and must be eliminated. Have you ever had a feeling of relief after exiting a bad trade just because you were out of a mess? Losing trades use more mental energy than winning ones.

A day-trader must become very mechanical, almost robotic. Many people who have come to the office to observe my trading style have commented that I appear almost emotionless. I believe to show emotion is to show fear: When your hand is shaking so much you can't pick up the phone, the market senses a victim is about to be slain and goes out for blood. This rule has evolved out of this fear factor.

3) After two hours of trading, ask yourself, "Do I feel good about my trading today?"

Once two hours have passed in the trading day, you should have made at least two, or perhaps more, trades but enough to evaluate what you have done. If you can answer "yes" to the question, continue trading. If your answer is "no," stop trading. You can't bring happiness to a "blue" day by trading. Your emotions won't allow it, and a big losing day is likely to be the result.

September 1995 is a true example for me of turning a bad family health situation into a bad financial situation. My father suffered a heart attack. He always was the pillar of strength to me, and to see him in intensive care was just too difficult.

Some people drown their problems with alcohol. My escape is trading, but during that time, my heart wasn't in it: My focus was gone; my energy level was low; my enthusiasm was non-existent. It turned out to be the worst trading month I had had in seven years.

The person who knows you best is yourself. Listen to yourself.

4) All cylinders of the engine must be running efficiently.

Keep in mind, as your trading day progresses, what money you have made or lost. It is much like knowing the score of a basketball game when you are the coach. Day-trading is a job, and your paycheck is determined by your ability. You only can maximize your ability if you have all the information you need to make trading decisions.

If your phone, quote machine or any other mechanical function of your daily routine is out of whack, stop trading. Frustration is the best friend of a losing day. The more frustrated you are, the less efficient your trading decisions will be, lowering the probability of a winning day. Don't fight a losing battle; there is always another day with opportunities.

5) Have complete faith in your indicators.

This is a must for success. Many times your indicators give a buy or a sell signal, and you don't follow it because you just don't have the confidence the signal is right this time. Successful day-traders believe in their indicators but also are aware that nothing is 100% foolproof.

Not taking a trade that is set up using indicators you have developed is calling yourself a liar.

The indicator is a product of you telling yourself to do a trade. When you reject it, you are responding by saying, "Indicator, you are not giving me a true signal." Grade yourself with a big red "F," and go sit in the corner.

6) To anyone who aspires to become a day-trader, observe those who are successful.

Any information you can procure on the trading philosophies, mechanics and techniques of the professionals is well worth your while. If learning from those who have experience cuts down your learning curve time, isn't it worth it?

I've heard people say they were going to learn by themselves. Learning for yourself will work if you have the time and financial resources. Stubbornness and pride can be hazardous to your wealth.

If you do pursue learning from the "masters," do not be surprised to find that there are many different ways to day-trade profitably. Do not try to clone another individual, because your personality is never exactly the same as his. Observe, learn and test the waters to arrive at the confidence level you will need to achieve consistent success.

7) Day-trading is a long-term commitment.

I fervently believe it takes several years to become a true professional. Each year you should become more consistent in your profits and enjoy more confidence in your indicators. My final daily rule means taking every trade and dissecting it. This will provide a roadmap for success by showing you where you have been, which mistakes you can learn from and which situations to avoid.

Day-trading is not easy, but as a business, it can provide the American dream -- financial independence.

Day-trading overview

Day-trading, which was once the exclusive domain of the floor trader, is now fair game for all speculators. Inspired in part by large intraday price swings, instant availability of quotes, affordable high-powered computers and competitive commissions, the new wave of day-trading methods and systems has attracted thousands of traders in recent years. The undeniable thrill of trading within the time span of one day is, however, a double-edged sword: one that can hurt as well as heal. To be successful, a day-trader must have the discipline of a machine, the instincts of a fox, the emotions of a rock, the skills of a surgeon and the patience of a saint. (And a little luck wouldn't hurt either.)

What is it about day-trading that attracts so many speculators to the markets? Are there effective methods for day-trading? Is successful day-trading more luck than skill? Is day-trading the proverbial "crap shoot?" Can day-trading be learned? Is the successful day-trader a different breed of "cat" than the successful position trader? Does day-trading offer advantages above and beyond position trading? Read on for the answers.

Day-trading defined In the summer of 1968, after making my first few trades in the commodity market (as it was called then), I learned quickly that floor traders clearly had the "edge" over the public. Floor traders were in the pits where the action was. They knew prices before the rest of us did. They traded for minimum commissions, and they seemed to know the news that affected prices before the rest of us. During one of my visits to the Chicago Mercantile Exchange, I was chatting with a retired floor trader in the visitors' balcony, and he asked what my trading interests were. I told him I was there to learn, that a broker was handling my account and that my knowledge of trading was very limited. He asked me if I was a "position trader" or a "day-trader." I confessed I hadn't heard either of those terms before. He offered the following definitions: A day-trader trades within the time frame of one day, entering and exiting positions within the day but always closing out trades by the end of the day, win, lose or draw.

This definition seemed logical enough to me. But the "old timers'" definition of position trading gave me cause to stop and ponder momentarily. He defined the position trade as a day-trade that ends the day at a loss.

After a few moments the definition struck home, and I laughed. But under the surface of my apparent amusement was an inherent market truth that has not left my mind since that day. Clearly, the ability to take a loss by the end of the day likely may be the salvation of many traders because the vast majority cannot take their losses when required to do so by their system(s), assuming, of course, they even have a system!

Giving up old ideas While many traders strongly oppose day-trading, I disagree. The long-standing "bad press" that has been given to day-trading and day-traders needs to be re-evaluated and abandoned. As I noted previously, computer technology and competitive commissions have changed day-trading forever. In fact, when examined logically in terms of the assets and liabilities of day-trading in comparison to position trading, the balance tilts clearly in favor of day-trading. Here is my list:

And there may be many other pros and cons as well. Of the above, the most significant pros are (1) forced to exit losses and (2) immediate feedback of results. Think at length about these two cogent benefits of day-trading, and I suspect you will agree with my assessment. But enough of philosophy and psychology -- let's get on with techniques and methods.

Technical day-trader Note that I consider the day-trader to be the ultimate technical trader as opposed to a fundamentalist. While fundamentals may rule a market in the long run, they are not nearly as important within the time frame of a day, other than, perhaps, to result in price swings based on news. The effective day-trader has methods for capturing moves based on the emotional response to fundamentally based news.

* Trend breakouts and trend following -- Of all the trading methods, following new trends or buying on breakouts to the upside and selling on breakouts to the downside ultimately may prove to be the most effective. In so doing, a trader follows prices higher or lower, taking stock in the belief that "new highs beget new highs" and "new lows beget new lows." Breakout systems date back to the excellent work of Keltner in the 1960s who pioneered various methods for taking advantage of price highs and lows for a given time frame. "S&P 500" (right) shows the ideal situation for a day-trader who buys a "breakout" of resistance. The good news here is although buying breakouts to the upside or selling breakouts to the downside tends to work well, it is psychologically difficult for most traders to do, and it requires traders to reverse positions when wrong. There are numerous methods for finding, validating and managing the risk in breakout systems.

Support and resistance trading -- This approach appears to make the most sense to traders. It involves two aspects: First, a trader must determine the underlying trend of the day and second, once the trend has been determined, a trader must determine the technical support level in an uptrend and the technical resistance level in a downtrend. When the trend is defined as up, a trader will buy at support levels, and when the trend is defined as down, a trader will sell at resistance levels. Profit taking and risk management strategies accompany this approach. While you may think this approach is obvious and self-evident, few traders actually can define the above terms operationally.

Daily seasonal trading -- Very few traders use this approach, yet I think it is a viable and worthwhile method. The pioneering work of Art Merrill in his classic book, The Behavior of Prices on Wall Street, clearly demonstrates the statistical reliability of pre-holiday behavior in the Dow Jones Industrial Average. Merrill showed that the odds of a higher-price close on the day before major U.S. holidays were not only very high but also statistically significant. Yale Hirsch in his outstanding book, Don't Sell Stock on Monday, demonstrated the value of using day-of-week statistics for market timing and trading. I have extrapolated from both of these works to determine the percentage of time the various futures markets have closed the day higher or lower than the previous daily close. Naturally the reliability of such data is a function of the data history. "Daily seasonal composite" (above) shows a portion of the daily seasonal futures charts I have developed for this purpose.

Daily sentiment trading -- The pioneering work of R.E. Hadaday in developing his Bullish Consensus indicator was instrumental in my development of the Daily Sentiment Index. The index provides a measure of public sentiment on a daily basis. This allows day-traders who follow a contrary opinion approach to fade the public sentiment when it reaches to levels that are too high or too low. The theory is that when daily sentiment is at 90% bullish or more, the public will be wrong, and hence, the day-trader will look for timing signals to trigger short-side entry and vice versa when the sentiment is 10% or lower.

Risk endures These are the major technical, philosophical and psychological issues the day-trader faces. They don't differ significantly from the issues that face the position trader. The only major difference is the time frame.

Because our world is growing rapidly smaller, and because market moves tend to be larger now within the smaller time frames than ever before, day-trading is not only viable and manageable but also preferable in many cases for the reasons cited previously. Of course, the viability of day-trading methods does not negate the risk of trading. Risk always lurks under the surface. No trading method is complete without an accompanying method for managing risk and dealing with the reality of losses, commissions and the cost of quotes, equipment and time.

How to find the right support and resistance

My personal preference for day-trading and short-term trading is to buy dips and sell rallies.

Two components are needed to make this strategy work. First, you have to be trading in the direction that gives you the best chance of success. Second, you have to be able to identify potential support or resistance for that trading day. I'll discuss one technique from each of these two components that make up my day-trading approach.

The first step is to determine which way the market is likely to go today -- in other words, is the trend up, down or sideways?

One method to determine the market trend involves a couple of old standby technical indicators that are available on virtually any charting software: the Moving Average Convergence Divergence (MACD) and the stochastic indicators. These oldies but goodies really can be useful if used in the proper combination.

Look at both the MACD and the Slow Stochastic on a daily chart to determine in which direction you want to trade the next day. For the MACD, I use a little longer time value for my inputs then the standard -- say, around a 10-30-10 exponential moving average combination. I also use a slow stochastic indicator with an input value of somewhere around 20 days.

Both of these indicators should be displayed together under the price data. Look for situations when both the MACD indicator and the stochastic indicator are on the same side of the signal line.

If both are above their respective signal lines, then trade the buy side. If both are below their respective signal lines, trade the sell side. Quite often you'll find the MACD and the stochastic indicators are on opposite sides of their respective signal lines. In these instances, avoid the market.

The alignment of the MACD and stochastic indicators together shows you the market trend. When both indicators are below the signal line, as they were in early December for both the S&P 500 Index and T-bonds, you should be a seller; if both are above the signal line, as they were in early February, you should be a buyer.

The accompanying charts show this simple combination eliminates a lot of noise from the market and identifies those times when the market has the best chance to make a trend move. Throw these indicators up on any chart together, and you will see this combination works infinitely better than either indicator alone.

Once you've determined the direction to trade, the next step is to find support if you want to buy or resistance if you want to sell. There are several ways to do this, and my usual strategy is to employ several methodologies to come up with a confluence or a "keypoint" high-probability trading zone.

Here is one methodology that is being described for the first time. There is no neat name for this indicator, so I'll just call it the 3x5ATR. To construct it:

1. Add up the true ranges for the last five days and divide by five. This is the 5ATR.

2. Calculate a three-day simple moving average of the highs and a three-day simple moving average of the lows.

3. To calculate the 3x5ATR for potential resistance, add the 5ATR to the three-day moving average of the lows. To calculate the 3x5ATR for support, subtract the 5ATR from the three-day average of the highs.

An important point is that this is not a total day-trading strategy. Look to combine other techniques that identify potential support and resistance points. A good rule to live by is to look for a confluence of support or resistance by integrating analysis techniques and integrating time frames.

Risk and Money Management

Trading commodity futures should be treated like a small business. Think about the budgeting and money management required to make a small business successful. To have a successful business, one should have a business plan, be sufficiently capitalized to weather downturns and unexpected adverse events, and keep accurate accounting data that should be analyzed periodically. A trader should have a trading plan, sufficient money in the account to overcome a series of losing trades, and keep good records of trades to be able to analyze them efficiently.

When developing a trading a plan, one important consideration is the amount of funds you are willing to devote to trading. A $5,000 account will have limitations that may not hinder a $100,000 account. Many books written about futures trading recommend not risking any more than three to ten percent of your equity on any one trade. The reason for this rule is to prevent one or two bad trades from destroying your account. Suppose you decide that you will not risk any more than ten percent of your equity on any on trade. If you have $10,000, your maximum risk will be $1,000 per trade, but if you have $5,000, your maximum risk is reduced to $500 per trade. The trading strategy that you choose should be dictated by the amount you are willing to risk. If the trading strategy you found to be successful in papertrading requires the risk to be an average of $1,500 a trade, and you choose to trade with an amount of $5,000, you must realize that you cannot afford to start off with a couple bad trades.

For example, traders ABC and XYZ are friends and they devise a system that over a long period of time, produces a winning trade 60% of the time, with the average winner being $540, and the average loser being $450, with a maximum risk of $700 per trade. ABC starts with $4,000 and XYZ starts with $7,000. Lets suppose the first six trades lose $1,400. ABC now only has $2,600 but XYZ has $5,600. The next two trades come along at the same time and have a required margin of $2,200. This situation already presents a dilemma for ABC because he knows that if the trades do not go in the right direction immediately, he could very easily find himself on a margin call. The margin call could lead to a decision to close out a trade prematurely, which in turn means he is unable to trade his plan. XYZ, on the other hand can still proceed, business as usual. This is one very simple example, but there are all kinds of scenarios where under capitalization hinders trading.

When setting up a trade, it is necessary to predetermine the amount of risk you are going to allow on the trade. That means come up with a stop loss. Successful traders always talk about having a stop loss or at least a mental stop loss prior to initiating a trade. Trading without a stop loss can lead to disaster for an inexperienced trader because they can find themselves unable to pull the trigger to cut losses until it is too late. One can also buy an option in the opposite direction of the trade to limit the potential risk instead of using a stop loss, but that is a discussion for another time. The main point again, is predetermining your risk on each trade.

Good record keeping is also a key element of managing risk. Record why you are entering and exiting a trade. This is important when you go back through your records to try to determine what is working or not working. This is part of learning how to make observations and being able to grow and learn as a trader. Looking for patterns in your winning and losing trades may lead you to the conclusion that your system is at fault, or you may find out that trader error (not following the system) is the problem. It is also recommended that you keep track of your equity closely so if an abrupt deterioration in equity occurs, you will be able to reassess and scale back your trading before it is too late.

Diversification of the markets you trade is also a key issue. In other word, do not put all your eggs in one basket. A trader may be in five different markets, but if those five markets are all long positions in wheat, corn, soybeans, soymeal and oats, he may soon find himself doing fantastic, or getting slammed in every trade. Don't take that chance with your equity.

Volatility can also make or break an account. If you have a $5,000 account, certain markets may not be appropriate. For example, the Japanese yen opened up almost 300 point’s higher one day, which could have been a loss of $3,750 for a short position. Coffee has jumped thirty cents ($11,250) in one day because of freezing overnight weather in Brazil's coffee growing area. Pork Bellies can go limit up or down several days in a row without any apparent rhyme or reason. It may be that it is a "thin" market (lacks volume and open interest). Trade with your eyes wide open.

Trade a consistent number of contracts. If you are in a winning trade, don't add contracts at an increasing rate. Too many times traders buy one position initially, buy one more, and because the trade is going so good insist on buying two or even three more, until the market suddenly turns on them turning a winning trade into a loser. Another tendency to avoid is to become over confidant and start trading larger quantities after a string of winning trades. You do not want to give back your profits faster than it took to make them.

We hope this article will have introduced the concept of managing risk and your risk capital when trading futures contracts. We realize that many individuals do not have the resources to begin trading with more than a few thousand dollars. It is true that small accounts can become large accounts by using a sound trading plan, but make sure that the risk capital which you allocate to trading can be lost without dire consequences. 

Disclaimer: There is a risk of loss in all commodity trading. The data contained are believed to be reliable, but have not been independently verified. Accordingly, such data cannot be guaranteed as to reliability, accuracy, or completeness, and as such are subject to change without notice.

Exchange Fees FAQ

1. What are exchange fees?

Exchanges are the legal owners of their market data. In some cases, they charge a monthly fee to those who receive real-time price quotes. These monthly fees are known as exchange fees.

2. Which exchanges are free?

You will receive market data from the following exchanges without exchange fees:

3. Which exchanges are subject to exchange fees?

The exchanges and their monthly fees are:

4. Where do the fees go?

All exchange fees collected are submitted directly to the exchanges.

5. How can I pay for access on the platform?

You can choose only the exchanges for which you want market data. All exchange fees will be billed monthly to your credit card; brokers have the required setup form. Exchange fees are collected and remitted to the exchanges by data vendor or the platform's market data provider.

Futures Orders types

Note: The same order may have different meanings depending on whether the order is to be executed in pit trading or through an electronic exchange.

Market Order

The market order is the most frequently used order. It is a good order to use once you have made a decision about opening or closing a position. It can keep the customer from having to chase a market trying to get in or out of a position. The market order is executed at the best possible price obtainable at the time the order reaches the trading pit.

Limit Order

The limit order is an order to buy or sell at a designated price. Limit Orders to buy are placed below the market while limit orders to sell are placed above the market. Since the market may never get high enough or low enough to trigger a limit order, a customer may miss the market if he uses a limit order. (Even though you may see the market touch a limit price several times, this does not guarantee or earn the customer a fill at that price.)

Stop Order

Stop orders can be used for three purposes:

A buy stop order is placed above the market and a sell stop order is placed below the market. Once the stop price is touched, the order is treated like a market order and will be filled at the best possible price.

Stop Limit Order

A stop limit order lists two prices and is an attempt to gain more control over the price at which your stop is filled. The first part of the order is written like the above stop order. The second part of the order specifies a limit price. This indicates that once your stop is triggered, you do not wish to be filled beyond the limit price. Stop limit orders should usually not be used when trying to exit a position. If a customer does not give a limit price, then the stop price and the limit price are meant to be identical.

Market If Touched Order (MIT)

MITs are the opposite of stop orders. Buy MITs are placed below the market and Sell MITs are placed above the market. An MIT order is usually used to enter the market or initiate a trade. An MIT order is similar to a limit order in that a specific price is placed on the order. However, an MIT order becomes a market order once the limit price is touched or passed through. An execution may be at, above, or below the originally specified price. An MIT order will not be executed if the market fails to touch the MIT specified price.

Good Until Canceled Order (GTC)

Good Till Canceled (or Open Order). Used in conjunction with a Limit or Stop order. Order will remain valid and worked until client cancels order, or it is filled, or contract expires.

GTC Order Does Not Cancel Automatically!

If an order is not designated Good Till Canceled, it is a Day Order and will expire at the end of the current trading session unless filled or canceled prior to the close.

One Cancels the Other Order (OCO)

One (order) Cancels (the) Other.

When one order is executed, the other is automatically canceled.

Market on Close (MOC)

This is an order that will be filled during the final seconds of trading at whatever price is available. PLEASE NOTE: A FLOOR BROKER RESERVES THE RIGHT TO REFUSE AN MOC ORDER UP TO FIFTEEN MINUTES BEFORE THE CLOSE DEPENDING UPON MARKET CONDITIONS.

Market on Opening (MOO)

This is an order that the customer wishes to be executed during the opening range of trading at the best possible price obtainable within the opening range. Not all exchanges recognize this type of order. One such exchange is the Chicago Board of Trade.

Enter and Cancel Order

All orders, except Market Orders, can be canceled and replaced with a different order unless filled prior to cancellation.

Spread Order

The customer wishes to take a simultaneous long and short position in an attempt to profit via the price differential or "spread" between two prices. A spread can be established between different months of the same commodity, between related commodities or between the same or related commodities traded on two different exchanges. A spread order can be entered at the market or you can designate that you wish to be filled when the price difference between the commodities reaches a certain point (or premium). For example: BUY 1 JUNE LIVE CATTLE, SELL 1 AUGUST LIVE CATTLE PLUS 100 TO THE AUGUST SELL SIDE. This means that the customer wants to initiate or liquidate the spread when August Cattle is 100 points higher than June cattle.

Or Better Order

The pit broker is obligated to get the best possible price for the customer. Putting an OB on an order does not cause him to work harder. If the price is NOT OB, the broker is irritated because he is paying special attention to a ticket that does not deserve it. Think of OB as MARKET with a LIMIT. If the price does not have an OB next to it, and the market is considerably better, the pit broker may question the runner to see if the order should have been a stop. They will return the order for clarification which could delay the filling of the order and possibly change the results of the fill. ONLY USE "OR BETTER" IF THE MARKET IS "OR BETTER."

Fill or Kill Order (FOK)

The fill or kill order is used by customers wishing an immediate fill, but at a specified price. The floor broker will bid or offer the order three times and immediately return either a fill or an unable.

RefcoLive Symbol List

Note: Highlighted symbols are not available for trading via the system. Account permissions and routing options will determine whether you are able to trade other symbols.

Prefix Code Description Exchange Contract Size
US SC 10 Yr. Swiss Bond -- EUREX EUREX CHF100,000
US LF 10-Year Agency Note -- CBT CBOT USD100,000
US LFA 10-Year Agency Note -- eCBOT eCBOT USD100,000
US MNI 10-Year Muni Note Index CBOT USD1,000 x BBI
US HB 90 Day Bankers Acc -- SFE SFE AUD1,000,000
US HX Australian 10 Year Treasury Bond SFE AUD100,000
US HT Australian 3 Year Treasury Bond SFE AUD100,000
US DA Australian Dollar -- CME CME AUD100,000
US DA6 Australian Dollar -- GLOBEX GLOBEX AUD100,000
US BP British Pound -- CME CME GBP62,500
US BP6 British Pound -- GLOBEX GLOBEX GBP62,500
US XQ British Pound -- Mid-Am MIDAM GBP12,500
US MG British Pound/Yen -- NYBOT NYBOT GBP125,000
US PIL CAC-40 Index -- MATIF MATIF EUR10 x Index
US CB Canadian 10-yr Government Bond -- ME ME CAD100,000
US BX Canadian 3 Month Bankers Acceptance -- ME ME CAD1,000,000
US CA Canadian Dollar -- CME CME CAD100,000
US CA6 Canadian Dollar -- GLOBEX GLOBEX CAD100,000
US NQL Central Appalachian Coal -- NYMEX NYMEX 1,550 tons of coal
US QC Cocoa -- LIFFE LIFFE 10 tonnes
US CC Cocoa -- NYBOT NYBOT 10 metric tons
US CF Coffee -- NYBOT NYBOT 37,500 lbs.
US CP Copper - High Grade -- COMEX COMEX 25,000 lbs.
US CPA Copper - High Grade -- COMEX/ACCESS COMEX ACCESS 25,000 lbs.
US C Corn -- CBT CBOT 5,000 bu.
US CNA Corn -- eCBOT eCBOT 5,000 bu.
US CT Cotton -- NYBOT NYBOT 50,000 lbs.
US CR CRB Futures Price Index NYBOT USD500 x Index
US NQM Crude Light e-miNY -- NYMEX (trades GLOBEX) NYMEX 500 barrels
US QO Crude Oil -- IPE (Brent) IPE 1,000 barrels
US CL Crude Oil -- NYMEX NYMEX 1,000 barrels
US CLA Crude Oil -- NYMEX/ACCESS NYMEX ACCESS 1,000 barrels
US DC DAX Cash Options -- EUREX EUREX EUR5 x Index
US DD DAX Index -- EUREX EUREX EUR25 x Index
US XM Deutsche Mark -- Mid-Am MIDAM DEM62,500
US DX Dollar Index -- NYBOT NYBOT USD1,000 x Index
US YM Dow Jones - $5 Mini -- eCBOT eCBOT USD5 x Index
US AI Dow Jones - AIG Futures -- eCBOT eCBOT USD10 x Index
US DSX Dow Jones Euro STOXX 50 -- EUREX EUREX EUR10 x Index
US DFA Dow Jones Industrail Average -- eCBOT eCBOT USD10 x Index
US DF Dow Jones Industrial Average -- CBT CBOT USD10 x Index
US D1 EURIBOR, 1 month -- EUREX EUREX EUR3,000,000
US FEU EURIBOR, 3 month -- EUREX EUREX EUR1,000,000
US QEA EURIBOR, 3 month -- LIFFE LIFFE EUR1,000,000
US DL Euro Bobl(5 Year) -- EUREX EUREX EUR100,000
US DB Euro Bund(10 Year) -- EUREX EUREX EUR100,000
US DG Euro Schatz(2 Year) -- EUREX EUREX EUR100,000
US EB Euro/British Pound -- GLOBEX GLOBEX EUR125,000
US GB Euro/British Pound -- NYBOT NYBOT EUR100,000
US YR Euro/Japanese Yen -- CME CME EUR125,000
US EK Euro/Swedish Krona -- NYBOT NYBOT EUR100,000
US RZ Euro/Swiss Franc -- NYBOT NYBOT EUR100,000
US EJ Euro/Yen -- NYBOT NYBOT EUR100,000
US EDO Eurodollar Mid-Curve (1 Year) -- CME CME USD1,000,000
US ED Eurodollar, 3 Month LIBOR -- CME CME USD1,000,000
US EDA Eurodollar, 3 Month LIBOR -- GLOBEX GLOBEX USD1,000,000
US EU EuroFX -- CME CME EUR125,000
US XG EuroFX -- Mid-Am MIDAM EUR62,500
US QNA Euroswiss, 3 Month -- LIFFE LIFFE CHF1,000,000
US EY Euroyen, 3 Month -- CME CME JPY100,000,000
US ZY Euroyen, 3 Month -- SIMEX SIMEX JPY100,000,000
US JEY Euroyen, 3 Month -- TIFFE TIFFE JPY100,000,000
US FF Fed Funds 30 Day Interest Rate -- CBT CBOT USD5,000,000
US FFA Fed Funds 30 Day Interest Rate -- eCBOT eCBOT USD5,000,000
US FC Feeder Cattle -- CME CME 50,000 lbs.
US FE Fortune e-50 Index -- GLOBEX GLOBEX USD20 x Index
US PB Frozen Pork Bellies -- CME CME 40,000 lbs.
US QFA FT-SE 100 Index -- LIFFE LIFFE GBP10 x Index
US HU Gasoline, Unleaded Regular -- NYMEX NYMEX 42,000 gal.
US HUA Gasoline, Unleaded Regular -- NYMEX/ACCESS NYMEX ACCESS 42,000 gal.
US QGA Gilt Long -- LIFFE LIFFE GBP100,000
US GC Gold -- COMEX COMEX 100 troy oz.
US GI Goldman Sachs Commodity Index -- CME CME USD250 x Index
US GD Goldman Sachs Commodity Index -- GLOBEX GLOBEX USD250 x Index
US HK Hang Seng Index -- HKFE HKFE HKD50 x Index
US HO Heating Oil -- NYMEX NYMEX 42,000 gal.
US HOA Heating Oil -- NYMEX/ACCESS NYMEX ACCESS 42,000 gal.
US IB IBEX-35 Plus Stock -- MEFF MEFV EUR10 x Index
US QJ Japanese 10 year Govt. Bond -- LIFFE LIFFE JPY100,000,000
US JGB Japanese 10 year Govt. Bond -- TSE TSE JPY100,000,000
US EJY Japanese Yen - E-Mini -- GLOBEX GLOBEX JPY6,250,000
US JY Japanese Yen -- CME CME JPY12,500,000
US JY6 Japanese Yen -- GLOBEX GLOBEX JPY12,500,000
US XY Japanese Yen -- Mid-Am MIDAM JPY6,250,000
US LH Lean Hogs -- CME CME 40,000 lbs.
US XH Lean Hogs -- Mid-Am MIDAM 20,000 lbs.
US EM LIBOR One month -- CME CME USD3,000,000
US LC Live Cattle -- CME CME 40,000 lbs.
US XL Live Cattle -- Mid-Am MIDAM 20,000 lbs.
US LB Lumber -- CME CME 110,000 bd. ft.
US MX Mexican Peso -- CME CME MXP500,000
US MX6 Mexican Peso -- GLOBEX GLOBEX MXP500,000
US MA Milk -- CME CME 200,000 lbs.
US YN Mini 10 Year U.S. Treasury Note -- eCBOT eCBOT USD50,000
US YH Mini 30 Year U.S. Treasury Bond -- eCBOT eCBOT USD50,000
US NMC Mini Coffee -- NYBOT NYBOT 12,500 lbs.
US YE Mini Eurodollars -- eCBOT eCBOT USD500,000
US YG Mini Gold -- eCBOT eCBOT 33.2 fine troy oz.
US YI Mini Silver -- eCBOT eCBOT 1,000 troy oz.
US YC Mini-Sized Corn -- CBOT CBOT 1,000 bu.
US YK Mini-Sized Soybeans -- CBOT CBOT 1,000 bu.
US YW Mini-Sized Wheat -- CBOT CBOT 1,000 bu.
US ENQ NASDAQ 100 Index - E-Mini -- GLOBEX GLOBEX USD20 x Index
US ND NASDAQ 100 Index --- CME CME USD100 x Index
US NDA NASDAQ 100 Index --- GLOBEX GLOBEX USD100 x Index
US ENC NASDAQ Composite Index - E-Mini -- GLOBEX GLOBEX USD20 x Index
US NG Natural Gas -- NYMEX NYMEX 10,000 MMBtu
US NQG Natural Gas e-miNY -- NYMEX (trades Globex) NYMEX 5,000 MMBtu
US NE New Zealand Dollar -- CME CME NZD100,000
US NE6 New Zealand Dollar -- GLOBEX GLOBEX NZD100,000
US NK NIKKEI 225 -- CME CME USD5 x Index
US ZN NIKKEI 225 -- SIMEX SIMEX JPY500 x futures price
US PNA Notional Bond -- MATIF MATIF EUR100,000
US NC NYSE Composite Index NYBOT USD500 x Index
US O Oats -- CBT CBOT 5,000 bu.
US OTA Oats -- eCBOT eCBOT 5,000 bu.
US XO Oats -- Mid-Am MIDAM 1,000 bu.
US OJ Orange Juice NYBOT 15,000 lbs.
US PA Palladium -- NYMEX NYMEX 100 troy oz.
US PAA Palladium -- NYMEX/ACCESS NYMEX ACCESS 100 troy oz.
US JM PJM Monthly Electricity -- NYMEX NYMEX 40 megawatt hours per peak day
US XP Platinum -- Mid-Am MIDAM 25 troy oz.
US PL Platinum -- NYMEX NYMEX 50 troy oz.
US PLA Platinum -- NYMEX/ACCESS NYMEX ACCESS 50 troy oz.
US LG Propane -- NYMEX NYMEX 42,000 gal.
US QA Robusta Coffee -- LIFFE LIFFE 5 tonnes
US RC Rough Rice -- CBT CBOT 2,000 cwt
US RCA Rough Rice -- eCBOT eCBOT 2,000 cwt
US ER2 Russell 2000 - E-Mini -- Globex GLOBEX USD100 x Index
US RI Russell 2000 Index -- CME CME USD500 x Index
US RU Russian Ruble -- CME CME RUR2,500,000
US RU6 Russian Ruble -- GLOBEX GLOBEX RUR2,500,000
US EP S&P 500 Index - E-Mini -- GLOBEX GLOBEX USD50 x Index
US SPA S&P 500 Index -- GLOBEX GLOBEX USD250 x Index
US SP S&P 500 Index --- CME CME USD250 x Index
US EMD S&P MidCap 400 - E-Mini -- GLOBEX GLOBEX USD100 x Index
US MI S&P MidCap 400 -- CME CME USD500 x Index
US ZT SGX Mini 10 Year JGB -- SIMEX SIMEX JPY10,000,000
US AP Share Price Index SFE AUD25 x Index
US QSA Short Sterling, 3 Month -- LIFFE LIFFE GBP500,000
US BS Shrimp - Black Tiger -- MGE MGE 5,000 lbs.
US SI Silver -- COMEX COMEX 5,000 troy oz.
US SIA Silver -- COMEX/ACCESS COMEX ACCESS 5,000 troy oz.
US SA South African Rand -- CME CME ZAR500,000
US SA6 South African Rand -- GLOBEX GLOBEX ZAR500,000
US SM Soybean Meal -- CBT CBOT 100 tons
US SMA Soybean Meal -- eCBOT eCBOT 100 tons
US BO Soybean Oil -- CBT CBOT 60,000 lbs.
US BOA Soybean Oil -- eCBOT eCBOT 60,000 lbs.
US XR Soybean Oil -- Mid-Am MIDAM 30,000 lbs.
US S Soybeans -- CBT CBOT 5,000 bu.
US SSA Soybeans -- eCBOT eCBOT 5,000 bu.
US MO Spanish 10 year Govt. Bond -- MEFF MEFF EUR100,000
US SU Sugar #11/World Raw -- NYBOT NYBOT 112,000 lbs.
US SF Swiss Franc -- CME CME CHF125,000
US SF6 Swiss Franc -- GLOBEX GLOBEX CHF125,000
US XF Swiss Franc -- Mid-Am MIDAM CHF62,500
US FJ Swiss Franc/Yen -- NYBOT NYBOT CHF200,000
US SW Swiss Market Index -- EUREX EUREX CHF10 x Index
US JTPX TOPIX Index TSE JPY10,000 x Index
US TX Toronto 35 Stock Index TOR CAD500 x Index
US MNIA U.S. 10 Year Municipal Note Index -- eCBOT eCBOT USD1,000 x BBI
US TY U.S. 10 Year Treasury Note -- CBT CBOT USD100,000
US TYA U.S. 10 Year Treasury Note -- eCBOT eCBOT USD100,000
US TU U.S. 2 Year Treasury Note -- CBT CBOT USD200,000
US TUA U.S. 2 Year Treasury Note -- eCBOT eCBOT USD200,000
US TB U.S. 3 Month Treasury Bill -- CME CME USD1,000,000
US TBA U.S. 3 Month Treasury Bill -- GLOBEX GLOBEX USD1,000,000
US XT U.S. 3 Month Treasury Bill -- Mid-Am MIDAM USD500,000
US FV U.S. 5 Year Treasury Note -- CBT CBOT USD100,000
US FVA U.S. 5 Year Treasury Note -- eCBOT eCBOT USD100,000
US XZ U.S. 5 Year Treasury Note -- Mid-Am MIDAM USD50,000
US US U.S. Treasury Bond -- CBT CBOT USD100,000
US USA U.S. Treasury Bond -- eCBOT eCBOT USD100,000
US MV Value Line Index -- KCBT KCBT USD100 x Index
US MW Wheat (Spring) -- MGE MGE 5,000 bu.
US W Wheat -- CBT CBOT 5,000 bu.
US WHA Wheat -- eCBOT eCBOT 5,000 bu.
US KW Wheat -- KCBT KCBT 5,000 bu.
US QW White Sugar -- LIFFE LIFFE 50 tonnes


Glossary of Futures & Options Terms

Name Description
Arbitrage The simultaneous purchase and sale of identical or equivalent financial instruments or commodity futures in order to benefit from a discrepancy in their price relationship.
Ask Also called "offer". Indicates a willingness to sell a futures contract at a given price.
Back Months The futures or options on futures months being traded that are furthest from expiration.
Bear One who believes prices will decrease.
Bear Market A market in which prices are declining.
Bid The price that the market participants are willing to pay.
Bull One who expects prices to rise.
Bull Market A market in which prices are rising.
Buy On Close To buy at the end of a trading session at a price within the closing range.
Buy On Opening To buy at the beginning of a trading session at a price within the opening range.
Cabinet Trade or cab A trade that allows options traders to liquidate deep out-of-the-money options by trading the option at a price equal to one-half tick.
Call An option to buy a commodity, security or futures contract at a specified price any time between now and the expiration date of the option contract.
Cash Commodity The actual physical commodity as distinguished from a futures commodity.
CFTC CFTC - The Commodity Futures Trading Commission as created by the Commodity Futures Trading Commission Act of 1974. This government agency currently regulates the US commodity futures industry.
Close, The The period at the end of the trading session.
Name Description
Closing Range (or Range) The high and low prices, or bids and offers, recorded during the period designated as the official close.
Commission (or Round Turn) The one-time fee charged by a broker to a customer when a futures or options on futures position is liquidated either by offset or delivery.
Contract Unit of trading for a financial or commodity future. Also, actual bilateral agreement between the parties (buyer and seller) of a futures or options on futures transaction as defined by an exchange.
Contract Month The month in which futures contracts may be satisfied by making or accepting delivery. (See delivery month.)
Day Order An order that is placed for execution during only one trading session. If the order cannot be executed that day, it is automatically cancelled.
Day Trading Refers to establishing and liquidating the same position or positions within one days trading, thus ending the day with open position in the market.
Deferred Another term for "back months."
Delivery The tender and receipt of an actual commodity or financial instrument, or cash in settlement of a futures contract.
Exercise Or Strike Price The price at which the holder (buyer) may purchase or sell the underlying futures contract upon the exercise of an option.
Expiration Date The last day that an option may be exercised into the underlying futures contract. Also, the last day of trading for a futures contract.
Floor Broker An exchange member who is paid a fee for executing orders for Clearing Members or their customers. A Floor Broker executing orders must be licensed by the CFTC.
Floor Trader An exchange member who generally trades only for his/her own account or for an account controlled by him/her. Also referred to as a "local."
Futures A Futures Contract is an agreement between a buyer and a seller to receive and deliver on a future date a specified amount of a product at an agreed price.
Futures Commission Merchant A firm or person engaged in soliciting or accepting and handling orders for the purchase or sale of futures contracts, subject to the rules of a futures exchange and, who, in connection with solicitation or acceptance of orders, accepts any money or securities to margin any resulting trades or contracts. The FCM must be licensed by the CFTC.
Hedge Hedgers are individuals and firms that make purchases and sales in the futures market solely for the purpose of establishing a known price level--weeks or months in advance--for something they later intend to buy or sell in the cash market.
Name Description
Holder One who purchases an option.
Initial Margin (Also referred to as Initial Perfor The funds required when a futures position (or a short options on futures position) is opened.
Limit Order An order given to a broker by a customer that specifies a price; the order can be executed only if the market reaches or betters that price.
Limit Price The maximum amount the contract price can change, up or down, during one trading session, as stipulated by Exchange rules.
Liquidation Any transaction that offsets or closes out a long or short futures position.
Long One who has bought a futures or options on futures contract to establish a market position through an offsetting sale; the opposite of Short.
Long Hedge The purchase of a futures contract in anticipation of an actual purchase in the cash market. Used by processors or exporters as protection against and advance in the cash price.
M.I.T. Market-If-Touched. A price order that automatically becomes a market order if the price is reached.
Maintenance Margin (also known as a Maintenance Pe A sum, usually smaller than--but part of--the initial margin, which must be maintained on deposit in the customers account at all times. If a customers equity in any futures position drops to, or under, the maintenance margin level, a "margin call" is issued for the amount of money required to restore the customers equity in the account to the initial margin level.
Margin (also known as Performance Bond) Funds that must be deposited as a margin by a customer with his or her broker, by a broker with a clearing member, or by a clearing member, with the Clearing House. The margin helps to ensure the financial integrity of brokers, clearing members and the Exchange as a whole.
Margin Call (also known as Performance Bond Call) A demand for additional funds because of adverse price movement.
Mark-To-Market The daily adjustment of margin accounts to reflect profits and losses.
Market Order An order for immediate execution given to a broker to buy or sell at the best obtainable price.
Minimum Price Fluctuation Smallest increment of price movement possible in trading a given contract, often referred to as a tick.
Nearby The nearest active trading month of a futures or options on futures contract. Also referred to as "lead month."
Name Description
Offer Also called "ask". Indicates a willingness to sell a futures contract at a given price.
Offset Selling if one has bought, or buying if one has sold, a futures or options on futures contract.
Open Interest Total number of futures or options on futures contracts that have not yet been offset or fulfilled by delivery. An indicator of the depth or liquidity of a market (the ability to buy or sell at or near a given price) and of the use of a market for risk- and/or asset-management.
Open Order An order to a broker that is good until it is canceled or executed.
Opening Price (Or Range) The range of prices at which the first bids and offers were made or first transactions were completed.
Opening, The The period at the beginning of the trading session during which all transactions are considered made or first transactions were completed.
Option A contract giving the holder the right, but not the obligation, hence, "option," to buy or sell a futures contract in a given commodity at a specified price at any time between now and the expiration of the option contract.
Out-Trades A situation that results when there is some confusion or error on a trade. A difference in pricing, with both traders thinking they were buying, for example, is a reason why an out-trade may occur.
Position An interest in the market, either long or short, in the form of open contracts.
Premium 1.) The excess of one futures contract price over that of another, or over the cash market price.
2.) The amount agreed upon between the purchaser and seller for the purchase or sale of a futures option --purchasers pay the premium and sellers (writers) receive the premium.
Put An option to sell a commodity, security, or futures contract at a specified price at any time between now and the expiration of the option contract.
Rally An upward movement of prices following a decline; the opposite of a reaction.
Range The high and low prices or high and low bids and offers, recorded during a specified time.
Reaction A decline in prices following an advance. The opposite of rally.
Registered Representative A person employed by, and soliciting business for, a commission house or a Futures Commission Merchant.
Name Description
Round-Turn Procedure by which a long or short position is offset by an opposite transaction or by accepting or making delivery of the actual financial instrument or physical commodity.
Scalp To trade for small gains. Scalping normally involves establishing and liquidating a position quickly, usually within the same day, hour or even just a few minutes.
Settlement Price A figure determined by the closing range that is used to calculate gains and losses in futures market accounts. Settlement prices are used to determine gains, losses, margin calls, and invoice prices for deliveries.
Short One who has sold a futures contract to establish a market position and who has not yet closed out this position through an offsetting purchase; the opposite of long.
Short Hedge The sale of a futures contract in anticipation of a later cash market sale. Used to eliminate or lessen the possible decline in value of ownership of an approximately equal amount of the cash financial instrument or physical commodity.
Speculator One who attempts to anticipate price changes and, through buying and selling futures contracts, aims to make profits; does not use the futures market in connection with the production, processing, marketing or handling of a product. The speculator has no interest in making or taking delivery.
Spread The simultaneous purchase and sale of futures contracts for the same commodity or instrument for delivery in different months, or in different but related markets. A spreader is not concerned with the direction in which the market moves, but only with the difference between the prices of each contract.
Stop Order (Or Stop) An order to buy or sell at the market when and if a specified price is reached.
Tick Refers to a change in price, either up or down.
Trend The general direction of the market.
Volume The number of transactions in a futures or options on futures contract made during a specified period of time.
Writer An individual who sells an option.


Risks - Budge - Try Hedge

The introduction of trading in Index Futures in the Indian markets will now enable operators, both individuals and institutional to hedge risks. Trading in financially engineered products such as futures, whose value is derived from the underlying asset - in this case the scrips on the index, will help operators to cover their positions into the future. The risk characteristics of emerging markets differ from those of more mature markets in fundamental ways. Even standard concepts such as hedge ratios or statistical measures such as correlation and volatility must be suitably interpreted before being applied. In addition, the relationships between these risk measures can undergo abrupt and dramatic changes, similar to the phenomenon of a "phase transition" in physics. The new risk regime which involves hedging trades can turn out to have quite the opposite effect and actually increase the risk of the position if one does not comprehend the concept and the nature of the derivative instruments. In order to manage risk effectively it is essential to move beyond the ordinary calculus of risk sensitivities and consider the effect of such a transition on one's portfolio. This article illustrates how portfolio transitions can be done in order to hedge risk and cover positions.

Managing Market Exposure in illiquid Markets

The estimation of statistical parameters such as volatility requires a time series of market data. This can be particularly troublesome in markets in which the underlying stock experiences only sporadic bursts of trading volume and although techniques have been developed to account for this, the net result is that a lack of liquidity reduces confidence in forecasting volatility. A general rule of thumb is that, for a short options position, when you most need to rehedge, the volatility will exceed your forecast. There is a common sense explanation to this: rehedging an illiquid stock will cause a greater market movement than for a corresponding liquid stock since it increases selling or buying pressure which in turn results in a greater movement in the stock price, and hence greater volatility.

The above aspect leads to a risk management paradox, which is illustrated by the narration of an incident below. A certain trader had a short options position on an illiquid stock. Because its price had recently dropped, he found himself with a net long position in the underlying stock. The risk manager dropped by and told him to "hedge it up" by the day's end. The trader tried to explain that the act of attempting to rehedge at that particular time would only drive the stock price down more and make matters worse, but the risk manager was unmoved. What did the trader do? He actually purchased more stock, which quickly drove the stock price up so much that his net exposure dropped to zero.

In the new risk regime what were intended as hedging trades can turn out to have quite the opposite effect, and actually increase the risk of the position.

The root of the difficulty here is that the very calculation of exposure in this case requires an assumption concerning the current stock price (not to mention also a forecast of volatility). For an illiquid stock the "current" stock price is really the expected transaction price, which depends upon whether one is a buyer or a seller, as well as the proposed size of the transaction. These issues are present as well for a liquid stock, only to a lesser extent. Of course during a general market disruption, all stocks become less liquid and so in that sense this principle generally applies.

Hence It becomes imperative to augment one’s risk profile by considering the effect of alternative risk scenarios and the positions that one is in.

How to whisk your oil price risk

Risk Management has been looked upon as rocket science by many finance professionals leave alone the layman individual. The introduction of derivative trading in India with BSE and NSE allowing trading in Sensex Futures has still not gained ground. Risk Management tactics employed by State Electricity Boards (SEBs) and the government of India in terms of the Escrow account failed miserably. The Indian government has now permitted oil companies in India to hedge against commodity price risks while importing crude and petroleum products. This initiative has been taken by the Indian government in a bid to protect the economy from the volatility of international crude prices. All oil companies having underlying exposures in crude and petroleum products will now be allowed to import and hedge future prices against the drastic volatility of the prices in the hydrocarbon sector. This has almost become a necessity for a country like India which imports 70 percent of its petroleum requirement and needs to be protected against such price movements in the International oil markets.

Oil companies such as the Indian Oil Corporation (IOC), Reliance Petroleum and MRPL are expected to be the beneficiaries of this move from the government. The hedging facility is to be subjected to detailed guidelines to be issued by the RBI and is expected to make Indian producers more efficient and enable them to compete in the International markets. The immediate beneficiaries of the decision will be the Industry experts opine that hedging instruments which are used for other commodities like sugar etc. are like insurance, both for the buyer and the seller, while the buyer can protect his interests by locking future physical deliveries at prices quoted at present, the seller too can protect his interest by contracting sales at a price which may fall in the consequent months.

The volatility in the International Oil markets can be gauged by the fact that oil prices have been roller coasting during the period December 1999 and April-May 2000. The prices in December stood at a historic low of barely $10 a barrel while by April-May it moved up to over $31 a barrel. Oil companies have gained or lost significantly due to the lack of price risk hedging instruments and have been unable to protect their future interests. Trading in oil futures (crude and petroleum products) take place at three exchanges across the world namely The Singapore Mercantile (Symex), The International Petroleum Exchange and The New York Mercantile (Nymex). India is mainly dealing with the International Petroleum Exchange at London.

The hedging mechanism is based on a benchmark crude for which price quotes are available. Each of the above exchanges that trade in oil futures have their own crude benchmarks. The Nymex has "Brent" which is crude from the North Sea as its benchmark while India will use the Dubai crude as its benchmark. India exports Dubai crude to supplement its oil requirements.

In the oil futures market, the quotes are usually for a period of about six months and the buyer of the future needs to take a position for a particular quantity to be physically delivered at a particular point of time. The advantage for the buyer would be that if prices moved up by the time that the physical delivery of the product takes place, the buyer is compensated with an adjustment and a settlement with the difference being paid back. The buyer thus is able to hedge against an increase in the prices of crude and petroleum products. In the case wherein there is a fall in the prices of crude and petroleum products then the sellers interest is protected as the delivery is made on the agreed price by the buyer.

For the Indian market the relevance of the permission by the government allowing oil companies to hedge against price risks in the crude and petroleum products markets lies in the facts that

Large crude buyers such as the Indian Oil Corporation, Reliance Petroleum and MRPL will be able to improve profitability.

The impact of the volatile international oil prices can be tamed by being able to hedge against price hikes using oil futures.

Lastly this will enable the Indian oil companies to gear up to competition from global oil players such as Morgan Stanley and Citibank who are poised the enter the Indian markets.

World Sugar

If surveyed most U.S. citizens would probably say that sugar comes from Hawaii, isn't that what it says on the bag? Though some sugar is; in this article we will discuss how and where sugar is produced and how the market can be affected.

First how and where is sugar grown?

There are two types of raw sugar; sugarcane and sugar beets. Sugarcane is like bamboo in nature, long and stalky. At maturity which takes 12-15 months the cane can reach 20 feet tall. Sugarcane is grown from cuttings of mature stalks instead of seeds and can be harvested 4 or more times per crop year. Sugar beets are tubular in shape and have a large white root that grows to 12 inches and at maturity weighs about 2 pounds. Beets are planted in the spring and harvested just before the first freeze in the fall. Though the two forms of raw sugar are very different, once they go through the refining process they are indistinguishable.

Sugar is produced in many different areas and countries. Sugarcane prefers to grow in tropical areas of the world with the leading producers being Brazil, India and Cuba. Most sugar beets come from the European Union, China, Thailand and Australia. The U.S. is the only country that produces both sugarcane and sugar beets which is mostly grown in Hawaii, Louisiana, Florida, California and Minnesota. The U.S. provides about 10% of our world sugar mostly in cane form.

What is World Sugar #11?

The sugar remaining after domestic consumption is called World Sugar #11. This is sold in a free market under special agreements and is regulated by the International Sugar Organization. The number 11 refers to the grade of sugar that is traded. Other grades can be used at a premium or discount at delivery.

What can move the market?

Supply: The supply of sugar is based mainly on how the crops yield each year. Sugar crops are susceptible to the typical pests and weather that other crops are. It can also be affected by other grades being accepted for #11 sugar. In 1995 the market declined heavily due to Brazilian sugar of a lower grade being accepted into the market. Other declines in the past couple years are from over production mostly from Brazil.

Demand: Sugar is still a luxury not a necessity. If income levels decline there is a lower demand for sugar. It can also be affected by political changes, import and export demands and current exchange rates.

Cocoa Fundamentals

The price of cocoa is influenced by a number of fundamental factors that affect demand and supply including climate, political instability, pestilence, regulations, and the economic strength of consuming countries.

Cocoa is grown in tropical climates found in Africa, South and Central America, and Southeast Asia. The Ivory Coast is by far the major producer of cocoa in the world followed by Ghana, Indonesia, and Brazil. Approximately 75% of the world cocoa crops are harvested between October and February. A second harvest, referred to as the mid-crop, takes place from May to August.

The cocoa tree thrives in humid, warm temperatures of 30 degrees C and requires minimum temperatures of 15 degrees C. Temperatures below 10 degrees C. can cause significant damage to the tree. Soil moisture is also critical, so rainfall needs to be plentiful and constant through out the year. Dry weather over a period three months can be detrimental to the size of the crop. A young tree can start producing three to five years after planting and will continue to produce for 25 years. In 1978 the price of cocoa was unusually high, priced above $5000 per metric ton, due to drought which killed many trees. However, within four years the price dropped down below $1500 per metric ton. The high price in 1978 most likely spurred new planting leading to overproduction.

A cocoa futures contract consists of the dried beans that are sold to processors who roast and grind the beans to produce a variety of products. The cocoa tree produces large seedpods which are split open to yield the beans in a mass of pulp. This mess is allowed to ferment for 1-7 days, depending on the grade of the beans. The juicy pulp is drained away leaving plump beans that have developed a rich fragrance and appear reddish brown in color. These beans are then dried in the sun or baked in kilns to reduce the moisture content to 7%, thus making them ready for shipping. The harvest of the beans is generally done by manual labor.

The main users or cocoa grinding countries are the United States, the Netherlands, Ivory Coast, and Germany. This information may be irrelevant to trading, but is interesting to chocolate aficionados like myself. Cocoa beans are first cleaned and roasted. A winnowing machine removes the shell leaving the cocoa “nibs.” A processor may use a variety of beans to get the result they want. These nibs go through an alkalization process to develop flavor. They are then milled (ground) resulting in “cocoa liquor”. The liquor can be pressed to yield cocoa butter and the resulting leftover mass referred to as “presscake” A processor can control the amount of cocoa butter extracted, to produce presscake with different levels of fat. The presscake is pulverized to give us cocoa powder. Chocolate as we know it is made by the cocoa liquor, additional cocoa butter, sugar, emulsifiers, milk (optional) and vanilla.

The International Cocoa Organization (ICCO) boasts membership of 42 countries, which represent 80% of world cocoa production and 70% of consumption. The ICCO issues quarterly reports on estimates of world production and usage. They also forecast production and consumption for the following year. For example in the 2000-01 forecast, production is expected to drop 7.6% to 2830 thousand tons, while grindings will increase 2.2% to 3007 thousand tons. This drop in production is probably in response to the very low cocoa prices that producers have had to deal with in 1999 and 2000. Cocoa prices hit an all time low in late 2000. In the early part of 2001, cocoa rallied from $750 to over $1200, perhaps in response the expected cut backs in production and higher consumption.

In 1972 the ICCO attempted to stabilize cocoa prices by creating export quotas and a Buffer Stock program to absorb excess production. Prices were relatively high through the 1970’s so the Buffer Stock program was not implemented until 1982. By then, the quota system had been discontinued by a new agreement made in 1980. The Buffer Program ran out of money after purchasing 100 thousand tons in 1981. It was not until 1988 that another 150 thousand tons were purchased. Member countries funded this Buffer Stock program by paying levies on imports and exports. The program was suspended as member countries started to have problems paying these levies and experienced disagreements. The 1993 agreement called for the liquidation of the Buffer Stocks over the next five years. Notice how the price of Cocoa rallied during those years contrary to logic. As silly as it may sound, resumption of the Buffer Stock program has become an issue again since the price of cocoa dropped so low in the year 2000. It is interesting to note that the price of cocoa did rally significantly in early 1981, in response to the expectation of the purchases by the program. But once the program was implemented, the impact was minimal in helping prop prices up.

In addition to supply/demand factors and weather concerns, other factors that can impact price are disease, such as witches’ broom, or infestation such as the Indonesian cocoa pod borer. Political instability can also have a short-term impact on prices. Just recently, the market had short-term rallies amidst a downtrend in the year 2000 due to military uprisings in Indonesia. International trade of product can be interrupted during these periods. Also, rumors or incidents of crop destruction in Africa, to protest low prices, led to short term price fluctuations in the futures markets. The consumption of chocolate is considered to be a luxury item in many countries so a major downturn in the world economies can also dampen demand. This may be a critical factor in 2001-2002 as many economies are facing a major downturn. There are other organizations that can exert influence on price by their policies. For example, the European Union issued a directive in 2000 (to be implemented by 2003) which allows the replacement of cocoa butter with cocoa butter substitutes up to 5% of the weight of the finished product. Many countries prohibit the use of substitutes in products sold as chocolate, including the United States.

Calculating Profits and Losses

Learn how to calculate profits and losses, read price quotations, and determine the the value of a given change in price. First we will define some useful terminology below.

Contract size- One contract represents a specific number of units of the commodity. For example, one wheat contract represents 5000 bushels of wheat. Unleaded gasoline contracts are for 42000 gallons. There are 40000 pounds per live cattle contract.

Point value- A change in price will result in a change in value of the contract. The point value specifies the dollar change in value of the contract per change in the price. The point value is derived from the contract size. This is illustrated by several examples below.

Cocoa has ten tons per contract. The price is stated in dollars per ton. If the price of cocoa is at $985/ton, the total value of the contract is ($985)x(10)= $9850. Suppose the price rises to $986/ton, then the total value is ($986)x(10)= $9860. When the price went from 985 to 986, we refer to that as a one point move. The change in value for the contract is $10. Therefore one point = $10.

Live cattle has 40000 pounds per contract and is quoted in cents per pound. Each cent in cattle is segmented into 100 points. For example, the prices is quoted at 76.65 cents per pound which can also read as $.7665. The total value of the contract is (40000)x(.7665)=$30660. If the price rises to $.7675, that is a ten point move in the price, the contract value changed $40. Therefore in Live cattle, one point equals $4.00.

Wheat has 5000 bushels per contract and is quoted in cents per bushel. It is common to see the price stated as $3.76 per bushel which is the same as saying 376 cents per bushel. The total value of the contract would be ($3.76)x(5000)=$18800. If the price moved one cent to $3.77, the total value would be ($3.77)x(5000)=$18850. Therefore, one cent = $50.00. In this example, if you were asked what the point value is for wheat, you would answer one cent equals $50, not one point equals $50. That is just the way it is.

Minimum tick- This term refers to the minimum amount the price can change as it is traded in the pit or electronically. For example, in Cocoa, the price can change from 985 to 986, so the minimum tick is one point. Wheat on the other hand can be divided into 1/4 cent increments, so you can see the price change from $3.76 to 3.76 1/4 to 3.76 1/2. Knowing the minimum tick is helpful in placing your orders properly.

We will next review the most popular futures contracts that are traded on the U.S. exchanges. After each commodity, in parenthesis will be the common abbreviation that the industry uses. We will use the following format to present key information about the commodity.

Contract Size (Point Value)

This will be followed by an explanation of how to read the quote, and then give an example on calculating the profit or loss between two prices.

GRAINS (Chicago Board of Trade)

**Soybeans (S), Wheat (W), Corn (C), and Oats (O)

5000 bushels $ 50/cent <1/4 cent>

Quotes on grains are often presented in various ways. Suppose the soybeans are trading at $5.12 1/2 per bushel. That can be interpreted as 512 1/2 cents. Depending on your source of information, it may be listed as the following.

5124 The last digit "4" represents 1/2. The last digit can be a 0,2,4, or 6.
5122 Read the quotes as 512 1/4
5126 Read as 512 3/4
5120 Read as 512 even

512.50 Some quote sources convert the fractions to decimals. Get in the habit of thinking in fractions on these grains.

Example: Soybeans moves from 512 1/2 to 519 1/4. This is a change of 6 3/4 cents which is multiplied by the point value ($50) which equals $337.50.

**Soybean Meal (SM)

100 tons ($1.00/point) <10 points>

Soybean meal is quoted in dollars per ton. A quote of 19850 tells us that it is trading at $198.50 per ton. Be aware that on many websites, the last zero is dropped so you may see 1985. Be sure to add the extra zero. An order in soymeal has to end in a zero. If you say you want to buy soymeal at 19855, your order will be rejected.

Example: Soy meal moves from 19850 to 21620. That is a move of 770 points at one dollar per point which equals a $770 move. Many traders will also refer to this as a move of $7.70 per ton.

**Soybean Oil (BO)

60000 pounds ($6.00/point) <1 point>

Bean Oil is quoted in cents per pound, and each cent is divided into 100 points. A quote of 2520 is .2520 per pound.

Example: The price moves from 2520 to 2573. That is a 53 point move, multiplied by $6.00 which equals $318.00.

**Rough Rice (RR or NR)

2000 cwt. ($20.00/cent) <1/2 cent>

Rough rice is quoted in cents per cwt. (100 pounds). So when you see a quote for 9105, interpret that as 910 ½ cents, or $9.10 ½ cents per cwt.

Example: The price moves from 9105 to 9175. That is a move of seven cents multiplied by $20/cent which equals $140.00.

MEATS (Chicago Mercantile Exchange)

**Live Cattle (LC), Lean Hogs (LH), Pork Bellies (PB)

40000 pounds ($4.00/point) <2 ½ points>

The meats are quoted in cents per pound. Each cent is divided into 100 points. So if Live cattle is trading at 75 cents per pound, some quotes read as .7500, and others as 75.00. To make it more confusing, you may also come across $75.00 per cwt. (100 pounds). Dropping the decimals helps. Another twist is that the price of meat futures contracts move in minimum ticks of 2 ½ points so must end in a 0,2,5, or 7. if live cattle is trading at 7502, that actually means 7502 ½. For whatever reason, dropping the last digit has become standard practice. But on your trade statements you will see that half point show up.

Example: lean hogs moves from 5625 to 5687. That is a move of 62 ½ points, multiply by $4.00 per point which equals $250.00.

**Feeder Cattle (FC)

50000 pounds ($5.00/point) <2 ½ points>

Feeder cattle is read like the other meats, with the only difference being the contract size and point value.

Example: Feeder cattle moves from 8965 to 9030. That is a move of 65 points, multiply by $5.00 per point, which equals $325.00.

SOFTS AND FIBERS (New York Board of Trade)

**Coffee (KC)

37500 pounds ($3.75/point) <5 points>

Coffee is quoted in cents per pound. Each cent is divided into 100 points. If coffee is trading at 70 cents per pound, you may see quotes listed as 7000, .7000 or 70.00.

Example: The price moves from 70.25 to 73.65. That is move of 340 points multiplied by $3.75/point which equals $1275.00. Regarding the five point minimum fluctuation; this market is notorious for the floor brokers restricting the orders they will accept when the market gets busy. They may require orders to be in increments of 10 points (7360 or 7370) or 25 points (7325 or 7350).

**Cocoa (CC or CO)

10 metric tons ($10/point) <1 point>

Cocoa is quoted in dollars per ton. There should not be any decimal points on the quote. If it reads as 1076, that means $1076 per ton.

Example: Cocoa moves from 925 to 1007. That is a move of 82 points ($82 per ton), multiplied by $10/point, which equals $820.

**Orange Juice (OJ or JO)

15000 Pounds ($11.20/point) <1 point>

Orange Juice is quoted in cents per pound. Each cent is divided into 100 points. If it is trading at 85 cents per pound, you may see 8500, .8500 or 85.00. Orders on orange juice have to end in a 0 or a 5 as this has been designated as the minimum tick.

Example: Orange juice moves from 9845 to 10135. That is a move of 290 points, multiplied by $1.50/point, which equals $435.00.

**Sugar (SB)

112000 pounds ($11.20/point) <1 point>

Sugar is quoted in cents per pound. Each cent is divided into 100 points. If it is trading at nine cents per pound, it may read as 900, 9.00 or .0900.

Example: If sugar is trading at 947 and moves to 1005, that is 58 points, multiplied by $11.20 per point, which equals to $649.60.

**Cotton (CT)

50000 pounds ($5.00/point) <1 point>

Cotton is quoted in cents per pound. Each cent is divided into 100 points. If cotton is at 67 cents per pound, you may see it as 6700, .6700, or 67.00. Be aware that most floor brokers want the orders to end in a 0 or a 5 (6705 or 6710), again indicating a minimum tick of 5 points.

Example: Cotton moves from 6630 to 6795. That is a 165 point move, multiplied by $5.00 per point, which equals $825.00.

**Lumber (LB) Chicago Mercantile Exchange

110000 board feet (1.10/point) <10 points>

Lumber is quoted in dollars per 1000 board feet. If lumber is trading at $234.50, it will read as 23450 or 234.50. Lumber must always end in a 0 because of the 10 point minimum tick.

Example: Lumber price changes from 23450 to 24120. That is a move of 670 points, multiplied by $1.10/point, which equals $737.00.

METALS  (New York Mercantile Exchange, COMEX division)

**Silver (SI or SV)

5000 troy oz. ($50.00/cent) <1/2 cent>

Silver is quoted in cents per troy oz. If silver is trading at $5.24 per ounce, you may see the quote stated as 5240, 52400, 5.240, or 5.2400. Although the price of silver fluctuates in half cent increments during trading, you will notice that the closing prices can end in different digits such as 5.247, 5.248 and so on.

Example: Silver price changes from 5245 to 5310. That is a move of 6.5 cents, multiplied by $50.00.cent, which equals $325.00.

**Gold (GC or GO) and Palladium (PA)

100 troy oz ($1.00/point) <10 points>

Gold is quoted in dollars per oz. If gold is trading at $289.50, the quote will be stated at 28950 or 289.50. What we refer to as one point is synonymous with one cent in the price of gold.

Example: Gold price changes from 28950 to 29470. That is a change of 520 points, multiplied by $1.00/point, which equals $520.00. Of course, many people will prefer to say that the price changed by $5.20.

**Platinum (PL)

50 troy oz ($.50/point) <10 points>

Platinum is quoted in dollars per troy oz. and is read the same way as the gold example above. But the contract size, thus the point value is different.

Example: Platinum moves from 52850 to 53940. That is a move of 1090 points, multiplied by 50 cents/point, which equals $545.00.

**Hi-Grade Copper (HG)

25000 pounds ($2.50/point) <5 points>

Copper is quoted in cents per pound, and each cent is divided into 100 points. If copper is trading at 83 cents per pound, the quote would read as 8300, 83.00, or .8300.

Example: Copper moves from 8250 to 8635. That is a move of 385 points, multiplied by $2.50 point, which equals $962.50.

ENERGIES  (New York Mercantile Exchange)

**Crude Oil, Sweet light (CL)

1000 barrels ($10.00/point) <1 point>

Crude oil is quoted in dollars per barrel, and each dollar is broken into 100 cents. Many traders talk in terms of points, which means one cent equals one point. So if Crude oil is trading at $25 per barrel, the quote will be 2500 of 25.00.

Example: Crude oil moves from 2504 to 2577. That is a move of 73 points, multiplied by $10/point, which equals $730.

**Heating Oil (HO) and Unleaded ( HU)

42000 gallons ($4.20/point) <5 points>

Prices for these two products are quoted in cents per gallon, and each cent is divided into 100 points. If the Unleaded or Heating oil is trading at 70 cents a gallon, the price would read as 7000, 70.00 or .7000.

Example: If the price of Heating oil moves from 7025 to 7140, that is a move of 115 points, multiplied by $4.20 per point, which $483.00.

**Natural Gas (NG)

10000 million BTU ($10/point) <1 point>

Natural Gas is quoted in dollars per million BTU. So if the price is at $5.00, then the quote would read as 5.000 or 5000.

Example: If the price of Natural Gas moves from 5035 to 5186, that is a move of 151 points, multiplied by $10/point, which equals $1510.00.

FINANCIALS (Chicago Board of Trade and Chicago Mercantile Exchanges)

**30 Year U.S. Bonds (US)

$100,000 face value ($31.25 per 1/32) <1/32nd>

The price of a bond is based on a yield of 6%, at which the price is at par or 100 even. If the yield is less than 6%, the price of the bond is greater than 100 and if the yield is greater than 6%, the price of the bond is below 100. The difference between 99 and 100 called a basis point. Each point is divided into 32 ticks. To confuse the new trader, many people refer to 1/32 as a "point" when they make their calculations. When reading a quote, think in terms of fractions. For example, 9925 or 99~25 should be interpreted as 99 25/32. Some data vendors convert the fraction into a decimal number, giving us 99.78125.

Example: The bond price moves from 99~25 to 100~07. That is a change of 14 ticks, or 14/32. Multiply by $31.25 per tick, which equals $437.50.

**Ten Year Notes (TY)

$100,000 face value (31.25 per 1/32)

Ten year notes are similar to the 30 year bonds in reading the quote and making calculations. They used to be read the same way until recently when the tick size became one half of 1/32. One would logically consider that to be 1/64th, but it is not done that way. Just treat it like a bond and if there is a half involved, you have to do a little extra math. The quote for the Ten Year has an extra digit to account for the halves. 99250 or 99~250.

Example: The ten year moves from 99~255 to 100~04. That is a move of 10.5 /32nds. Multiply 10.5 by $31.25 and the value of the move is $328.125.

**Eurodollars (ED) and T-Bills (TB)

Principle $1 million ($25.00/point)

The Eurodollar and T-Bill futures are interest bearing time deposits with a three month maturity. So short term interest rates are tied to the price of these futures contracts. If the price is going up, that implies the interest rate or yield is going down. If the price is going down, the yield is going up. Over the years, the Eurodollar has become the most actively traded futures contract and the T-bill futures have declined in volume. Speculators of short term interest rates should trade the Eurodollar contract! The price of the contract is often shown as 94520 or .94520. The last digit is for halves. If the interest rate is equal to zero, the contract price should be 1.00000.

Example: The Eurodollar moves from 94520 to 94595. That is a move of 7.5 points, multiplied by $25, which equals $187.50.

**Libor (EM)

This contract is treated like the Eurodollar. It is a time deposit with a one month maturity and the principle amount is $3 million.

**Euroyen (EY)

100 million yen (2500 yen/point)

The Euroyen is a time deposit of yen with a three month maturity. This contract is denominated in Yen, hence the point value is stated in yen. the point value in terms of U.S. dollars fluctuates with the exchange rate between the yen and the dollar. Reading the Euroyen is similar to reading the Eurodollar.

Example: If the Euroyen moves from 99550 to 99600, that is a five point move. Multiply by 2500 yen, which equals 12500 yen. If the exchange rate is at 117 yen per dollar, divide the 12500 yen by 117, which equals $106.83.


A stock index takes the total value of a given collection of stocks. It gives the trader a measure of strength or weakness of prices for a certain group of stocks. For example, the S&P 500 contains 500 companies representing a wide variety of publicly traded companies. 80% of the companies are traded on the New York Stock Exchange. The NASDAQ 100, on the other hand primarily lists the top computer and communications related companies traded on the NASDAQ exchange. Also included on the list are some major biotech stocks and several non-technology stocks.

**S&P 500 (SP) and Emini S&P (ES)

250X Index ($2.50/point) <10 points> Regular size
50X Index ($0.50/point) <25 points> Emini

Examples: If the S&P moves from 1305.80 to 1316.30, that is a 1050 point move, multiplied by $2.50/point, which equals $2625.00.
If the Emini S&P moves from 1305.75 to 1316.25, that is a 1050 point move, multiplied by $0.50/point, which equals $525.00.

**Nasdaq 100 (NQ) and Emini Nasdaq (EN)

100X Index ($1.00/point) <50 points> Regular size
20X Index ($.20/point) <50 points> Emini

Examples: If the Nasdaq moves from 2227.50 to 2318.00, that is a move of 9050 points. For the regular contract multiply by $1.00/point which equals $9050.00. For the mini, multiply by $0.20/point, which equals $1810.00.

**Dow Jones (DJ)

10X Index ($10/point) <5 points>

If the Dow Jones moves from 10765 to 10540, that is a 225 point move, multiplied by $10.00/point, which equals $2250.00.

**Mini Value Line (MV)

100X Index ($1.00/point) <5 points>

Example: If the Mini Value Line moves from 1238.50 to 1246.20, that is a 770 point move, multiplied by $1.00/point equals $770.00.

CURRENCIES (Chicago Mercantile Exchange)

The currencies are stated in terms of how much that currency is worth in U.S. dollars. For example if the quote for the Swill Franc is at .6750 or 67.50, it means that one Swill Franc is worth 67 ½ cents in U.S. dollars.

**Japanese Yen (JY)

12,500,000 yen ($12.50/point) <.000001>

One Japanese Yen is often times worth less than a penny, so the quote has a couple zeroes in the beginning. Many quote sources drop these zeroes. For example .008950 would often times be quoted as 8950 or .8950.

Example: If the yen is trading at 8950 and rises to 8984, that is a move of 34 points, multiplied by $12.50/point which equals $425.00.

**Eurocurrency (EC)

125,000 units ($12.50/point) <1 point>

The Eurocurrency, commonly referred to as the Euro FX is a relatively new currency formed by a number of European countries. For example, Germany is one of the countries participating and the D-mark is slowly being phased out. If one Euro FX is worth 91 cents, the quote may read as .9100, 91.00 or 9100.

Example: If the Euro FX moves from 9167 to 9198, that is a 31 point move, multiply by $12.50, which equals $387.50.

**Canadian Dollar (CD) and Australian Dollar (AD)

100,000 dollars ($10.00/point) <1 point>

If the Canadian or Australian dollar exchange rate is at 65 cents, then the quote may read as .6500, 65.00 or 6500.

Example: If the Canadian or Australian dollar moves from 6523 to 6576, that is a 53 point move, multiply by $10.00/point which equals $530.00.

**British Pound (BP)

62500 pounds ($6.25/point) <2 points>

If one British pound, also called a sterling, is worth $1.50, then the quote would read as 1.5000, 150.00 or 15000. Since the minimum tick is 2 points, the number always ends with an even number.

Example: If the Pound moves from 15238 to 15416, that is a 178 point move which is multiplied by $6.25/point which equals $1112.50.

**Swiss Franc (SF) and German Mark (DM)

125000 units ($12.50/point) <1 point>

If the Franc or Mark exchange rate is at 52 cents, the quote will is presented as .5200, 52.00 or 5200.

Example: If the franc or mark moves from 5250 to 5275, that is a 25 point move multiplied by $12.50 which equals $312.50.

**Mexican Peso (ME)

500,000 Pesos ($5.00/point=.00001) <2.5 points>

Since the minimum fluctuation is 2.5 points, when you see a quote, there will be an extra digit to account for the halves. If the quote is .160125 or 16.0125, that means one peso is worth 16.0125 cents each.

Example: If the peso moves from 160000 to 163000, that would be a 300 point move, multiplied by $5.00/point, which equals $1500.00

**U.S. Dollar Index (DX) New York Board of Trade

1000X Index ($10.00/point) <1 point>

The Dollar index is a weighted average of six currencies which include the Euro FX, Yen, Pound, Canadian Dollar, Swiss Franc, and the Swedish Krona. The base price is 100 which would read as 10000 or 100.00. The higher the number, the stronger the U.S. Dollar against the is collection of currencies.

Example: If the Dollar moves from 101.75 to 102.35, that is a 60 point move, multiplied by $10/point, which equals $600.00.

Bull Call Spread

The Bull Call Spread is one of the most popular forms of options spreading. In this type of spread you would buy a call at a particular strike price and sell a call at a higher strike price in the same commodity. Typically, both options are traded in the same contract month. Bull Call Spreads tend to be profitable if the underlying futures contract settles at or above the higher strike price (the option that you sold) upon expiration - therefore this is a bullish position because it relies on the underlying future moving up in price.

These spreads typically require less cash outlay than the outright purchase of a call option, and therefore have less risk / profit potential. It can never lose more than the initial cost plus commissions, and does not require margin to be posted. This spread will never yield a profit larger than the difference between the strike prices less the cost of establishing the position. In contrast, remeber that the outright purchase of a call option only involves one commission and has an unlimited profit potential.

Because of these limitations a trader will only want to use this strategy under certain conditions. It is usually used when trying to pick a "bottom" in a market, when volatility in that market is fairly high, and as a result the outright purchase of an option is too expensive.
Bull Call spreads are established by buying a call and selling a higher strike price call option in the same contract month of the same commodity. Both risk and reward are limited.

The premium paid for the near the money option less the premium received for the out of the money option plus commissions is the cost of the position.

The maximum risk in this positions is limited to the total premium paid, plus commissions

The maximum reward is limited to the difference in the strike prices, the higher versus the lower, less the initial cost of the position.

Here are some guidelines to use when considering this type of trade:

Try to keep your risk exposure around $300.00 plus commissions. Plan to liquidate the position if the value of the spread moves below a liquidating value of $300.00 or less than the initial cost of the position.

These spreads work best when you enter an option with at least three months of time value, because it is necessary to give the market enough time to move to it's full profitability. As in all wasting assets time to expiration is critical for your strategy to work.

This strategy seems to work best when the purchased option is close to, or at the money, meaning that the futures market is at or near the strike price of the option that you purchased.

Commodtiy Trading

Author: Dieter Selzer-McKenzie