The ABC's OF Futures Trading

Futures trading deals with trading Futures Contracts. What precisely is a Futures Contract. How does one trade it? A Futures Contract, also known as a cash forward sale or a "Forward" Contract, is a contract between a buyer hooked on a specific product, and a seller engaged in supplying the same product for a specific future date. Futures Contracts are formal agreements, meaning that they obligate both the buyer and seller; neither can default. Futures Trading is defined as a zero sum game. What that means is that every dollar made by the buyer is a dollar lost to the seller and vice versa. When prices are too high or too low, then it is the buyer or the seller that profits, but they profit at the expense of the other. Let's see an example. Say pork belly prices rise, the farmer benefits but the bacon manufacturer suffers. If pork belly prices fall, the farmer suffers, but the bacon manufacturer's bottom line improves.

Futures trading takes place in two ways. First, commodities are traded on the floor of a Futures exchange, such as the Chicago Mercantile Exchange (CME). There trading takes place in an open outcry pit. But Futures trading can also take place "electronically," over the internet, where individual traders put in their buy/sell orders from their desktop trading platforms.

Futures traders can be broken into 2 groups, hedgers and speculators. An example of a hedger would be a farmer, manufacturer, exporter or importer. The goal of the hedger is to create futures positions that reduce the risk that the price of their commodity may fall. For example, a pork belly farmer believes that his pigs will be grown by August. He signs a pork belly futures contract before the slaughter at the current price in May for delivery in September. In May, the price of pork bellies is high because of reduced supply. Should the price of pork bellies drop by September (when the contract expires), the farmers' price has already been ensured. Mind you, the farmer is assuming a risk. What if there is a virus and many pigs die before September. The price of pork bellies would rise even further, but the farmer is already obligated to deliver pork bellies at the price negotiated in May. The farmer would lose additional profit. Conversely, in September there might also be a huge number of pigs and the price of pork bellies ends up being lower than his May price. In this case he wins.

Speculators want to be trading Futures to earn a profit, not to protect the price of their commodity. Speculators actually embody the majority of traders in almost all markets. Speculators are able to assume risk. They hope that if they buy low, they can sell high by going long. Oppositely, speculators can sell high and later buy back low, going short. As an example, say the pork belly speculator knows that there has been a virus and pork bellies will be limited in September. The speculator is happy to buy the pork bellies Futures contracts in May at the current price. He is betting that the price of pork bellies will skyrocket and he will make a fortune in September after the small roundup. Speculators give the Futures Market liquidity that is needed. Without speculators, no one would accept the other half of the hedger's contracts. As in the example above, the farmer sells the pork bellies to the speculator in May for the current price. The speculator assumes risk, hoping that by September, the delivery date, the price of pork bellies has risen back up and he can make a profit at the farmer's expense. What he really doesn't want to happen is that in September, the price of pork bellies goes down, meaning that he paid far too much, and he is the loser.

Prior to organized Futures exchanges, like the Chicago Mercantile Exchange (CME), Futures trading was a far more risky proposition. Contracts were drafted between one farmer and one speculator, and signed wherever the farmer happened to be selling his produce, for example, in farmers markets. There were a lot of problems with these personal contracts. First and foremost, either the farmer or the speculator was allowed to default on the contract. Who would enforce payment or delivery? If the speculator was going to lose his shirt, he would not complete his side of the contract. If the farmer realized that the price of pork bellies had risen dramatically, he would default and sell the pork bellies in the open market. Since these contracts were drafted between 2 parties, the speculator could not sell his contract to another speculator. Here's another problem...there was no one who would certify the quality of the delivery. Farmers could fill their side of the contract with lower grade pork bellies, and the speculator could not do much about it.

Since the start of organized exchanges, it became the job of the exchange to validate quality, payment and delivery. Exchanges regulated that now good-faith money was required with a third party to make sure of contract performance. This reduces the number of contract defaults. Exchanges were finally able to standardize contracts, stipulating the terms of each contract, like commodity delivery dates and product grades.

Organized exchanges have taken Futures trading far beyond buying and selling of just commodity contracts like corn, wheat, rice, soy or pork bellies. Today, there are futures contracts for several different asset classes, including energies, treasuries, currencies and equities. Futures belong to an asset class called "derivatives," securities whose prices are derived from one or more underlying assets. As an example, the S&P 500 Futures Contract underlying asset is the New York Stock Exchange's (NYSE) S&P 500 Index. The S&P 500 Index is one of the most intensely watched equity indexes around the world. The index represents the top 500 well recognized stocks that are now traded on the NYSE. Here is the difficulty with the S&P index, however...you cannot trade the Index. The CME devised the S&P 500 Futures Contract that you are able to trade. As with the case of the S&P 500 Futures Contract, when the value of the S&P 500 Index inflates, the S&P 500 Futures Contract inflates with it, and vice versa.

Here the resistance fractal (green dot/dash line) crosses below the support fractal (red dot/dash line) causing the trend to be upside down. When that happens, we can expect a large move in price as the Market corrects itself. To determine the direction, watch the proprietary trend lines (brown and orange dot dot/dash).

There are also future derivatives whose underlying asset is a currency index. For smaller investors, the Currency Futures Market is created for the few contracts that individual investors intend to trade. Trading with Currency Futures, individual investors can trade the exact same dollars/euros that are being traded in the Forex market, but trade them on the CME.

Shadowtraders specializes in training individual investors in Trading Futures. Most other Futures education companies are limited to training only the S&P 500 Futures Contract, and specifically the Emini, earmarked to individual traders. Shadowtraders is far more interested in introducing its clients to a variety of different Futures, including energies, currencies, treasuries, etc. We trade assets with liquidity and volatility. We know the days of the week that a particular Futures contract trades, the times of day it trades best, how many contracts are traded for that, whether or not you can it at all, etc. That is Shadowtraders specialty.

If you are experiencing losses trading the S&P 500 Emini, or if you are new to the Futures trading game and want to get more information, attend the Shadowtraders Webinar held on Monday nights.

TRADING DISCLAIMER All TRADING involves high risk and YOU can LOSE a substantial amount of money, no matter what method you use. All trading involves high risk; past performance is not necessarily indicative of future results. Commission Rule 4.41(b)(1)(I) hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not actually been executed, the results may have under- or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE IS RISK OF LOSS IN ALL TRADING. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. ALL RESULTS ARE HYPOTHETICAL. NO IMPLICATION IF BEING MADE THAT ANYONE UTILIZING ANY OF THE SERVICES OF SHADOWTRADERS HAS OR CAN OBTAIN SUCH PROFITS AND RESULTS. THIS INFORMATION IS NOT A RECOMMENDATION TO BUY OR SELL AT THIS TIME, BUT MERELY A PRESENTATION OF TRADES STRATEGIES. THE INFORMATION CONTAINED HEREIN HAS BEEN OBTAINED FROM SOURCES BELIEVED RELIABLE, BUT IS NOT GUARANTEED AS TO THE ACCURACY OR COMPLETENESS. PLEASE CHECK MARKET FUNDAMENTALS AND TECHNICAL CONDITIONS BEFORE CONSIDERING THESE OR ANY TRADES. This is not a prospectus; no offer on our part with respect to the sale or purchase of any securities is intended or implied, and nothing contained herein is to be construed as a recommendation to take a position in any market. It is possible that at this date or some subsequent date the officers, directors and/or shareholders of Shadowtraders and its affiliates own securities, or buy or sell securities mentioned in this publication or those not so mentioned. The intent of the Shadowtraders information supplied to SUBSCRIBER is for instructional purposes only. Shadowtraders information supplied to SUBSCRIBER is intended to be purely educational. The material presented herein has been obtained or derived from sources believed to be accurate, but we do not guarantee its accuracy. There have been no promises, guarantees or warranties suggesting that any trading will result in a profit or will not result in a loss. SUBSCRIBER is responsible for his own actions regarding an trading.

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