Futures For You
| INSIDE THE FUTURES
WORLD
Want to learn how the futures markets really work? Dan
O'Neil, a principal at online futures and forex broker Xpresstrade (www.xpresstrade.com),
responds to your questions about today's futures markets.
To submit a question, post your question to our website
at http://Message-Boards.Traders.com. Answers will be posted there, and
selected questions will appear in a future issue of S&C. |
Dan O'Neil |
STOP BEFORE THE RED
How important are stop orders in futures trading?
Most successful traders agree that good risk management is essential
in the futures markets. To this end, trading with protective stops is an
integral part of a disciplined trading methodology. While some traders
avoid using stops for fear of being taken out of a good trade too early,
the risk of inaction is often far greater.
A stop is an order that becomes a market order when the futures contract
reaches a particular price level; a sell-stop is placed below the market,
while a buy-stop is placed above the market. The underlying idea is to
minimize losses should the market turn against you.
In recent years trailing stops have gained in popularity because they
allow the trader to profit from favorable movement in the market while
also having protection in place. A trailing stop is usually entered with
a primary order to establish a new position. It is not entered at an exact
price, but rather at a specified distance from the price at which the primary
order will be filled. Once the primary order is executed, the trailing
stop will begin to work according to market fluctuation.
To get an idea of how this setup behaves, think of the market and the
trailing stop as though they were connected by a chain. When the market
moves in your favor, the chain becomes tight and the trailing stop is dragged
along. But when the market changes direction and starts to move against
you, the trailing stop price remains steady. Once the designated price
has been reached, the trailing stop immediately converts into a market
order to offset your open position in the market.
Because of the importance of risk management in trading the futures
markets, the effective use of stops and trailing stops may be one of the
most important fundamentals for traders to grasp.
THE MYTHS OF FUTURES TRADING
I'm considering diversifying my portfolio by getting into futures,
but I'm concerned about things I've heard. It sounds like I'll need a lot
of money to get started, the risks seem high, and I don't really want a
truckload of soybeans in my front yard. Am I right to be worried?
Despite the attractiveness of commodity futures and options as investment
vehicles, the fact that they don't get as much coverage as stocks has allowed
a number of misconceptions about these markets to circulate. Let's take
a look at the real story behind three myths about the futures markets:
1. I need a lot of money to trade futures. While this may have been
true years ago, many products now available to retail investors have made
investing in these markets easier and more affordable than before. Emini
contracts in many popular markets like the Standard & Poor's 500 and
gold futures can represent thousands of dollars, but investors need only
pay a small percentage in initial margin to begin trading, often as little
as $500.
However, it's possible to trade commodities that don't offer mini versions
as long as you manage your money wisely. If your account size is limited
to $5,000 or $10,000, make sure you're discriminating in choosing your
positions and calculate your potential loss before you enter into a trade.
Many smaller traders can be active for a long time simply by applying a
disciplined strategy to their trading.
2. Futures are too risky - I can lose my money before I know what hit
me. Like all investment vehicles, futures carry risk. In fact, because
these are often highly leveraged transactions, not only can you lose the
principal you invest, but in some cases, you might lose more. That's why
brokerage firms monitor your account and positions. When the amount of
capital in your account draws down due to adverse market movements, your
broker will issue a margin call, allowing you to add funds into your account
before your positions are liquidated. This helps prevent your entire account
capital from being depleted. If you deposit the full contract amount in
your account rather than trading on margin, this is not an issue.
It's worth pointing out that maintaining an investment portfolio without
futures can be considered risky, as futures can be used to hedge other
positions. If most of your portfolio is invested in stocks, you'll lose
money when the market goes down. But by holding positions in commodities
such as gold - which moves contrary to the stock market - you may make
money to offset those stock losses.
3. I'm going to get a load of corn delivered to my door! This is a common
concern for newcomers, but in reality, many contracts available these days
to retail investors don't even offer the option of taking delivery of a
physical commodity contract - they are purely speculative and hedging instruments.
In other cases, it's going to be difficult for you to accidentally take
delivery of a commodity. To do so, you need to hold the contract past its
first notice day, and then begin a process that includes financing the
entire underlying value of the particular contract. Most brokerage firms
will notify you if you're holding a contract that is approaching the day,
and unless you have specifically made arrangements with your firm, most
will liquidate the contract even if they cannot get in touch with you.
Originally published in the January 2007 issue of Technical Analysis
of STOCKS & COMMODITIES magazine. All rights reserved.
© Copyright 2006, Technical Analysis, Inc.
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