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In This Issue:
Jeff Friedman uses his 30 years of experience to answer frequently asked questions about trading futures.

February 28, 2007
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Free Market Data at Your Fingertips, Including Historical Charts

 

 

 

 

 

 

 

Crude Oil is On the Move! Trade 10
Commission-Free
Contract Sides

 

 

 

 

 

 

 

Free Lind eWire
Newsletter. Information
and Strategies for
Traders of All Levels

 

 

 

 

 

 

 

Try Trading Futures
Risk-Free, and Get
Lind-Waldock’s Free
“Why Futures Now” Guide

 

 

 

 

 

 

 

FREE Lind-Waldock
Futures Technical
Trading Guide

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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Published By Traders Media

Futures FAQ and Trading Techniques

I’ve been involved in the futures industry for 30 years, and naturally I’ve had many clients ask me many questions about futures trading. I’d like to share a few of the most frequently asked questions I’ve encountered, and provide answers from my point of view.

These are just my opinions, I’m not always right or wrong, I don’t have the Holy Grail, and what I’m telling you is in no way going to guarantee profits. There is no way anyone can do that. Markets are ever-changing, and what made the markets do what they did yesterday, may not do the same thing tomorrow under similar circumstances.

I typically get the most questions about fundamental factors, technical analysis, and risk management. So those are the areas I will focus on. Of course, if you have other questions, I welcome you to contact me and I’ll do my best to answer yours.

(continued below...)


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Question: What’s the difference between fundamental and technical trading?

Let’s define the differences between fundamental and technical analysis, so you can determine which you might want to consider when you make your trading decisions. Fundamental factors are the economics behind the markets you are trading; in essence, supply and demand factors that influence price. Fundamental analysis can take a long time to learn. It’s not that you have to be a genius, it’s just that there is so much unique information to digest for each market, each and every day. Some of it can even be conflicting, so it takes time to understand why and how a particular piece of data might influence market direction. Fundamental factors affecting the price of corn (such as the weather) are likely to be different than those impacting Treasuries (such as an employment report), or the Japanese yen (such as Bank of Japan policy statement). Even if you are trading one market, such as the S&P 500 futures, there are a multitude of fundamental factors every week that can influence trade, including corporate earnings reports, geopolitical events, the employment picture, the housing market, and consumer sentiment, just to name a few.

Technical analysis, on the other hand, is the study of price and price behavior using various chart techniques. You are simply studying past price behavior using a visual representation, (a chart) to help make your decision about where prices might be headed next. While technical analysis itself can also be complex, a chart is a chart, and once you’ve chosen and become familiar with your favorite technical indicator or indicators, technical analysis methods can be applied in similar fashion to virtually any market. Technical analysis actually incorporates all the fundamental information for you, reflected in the price you see on the chart.

Question: Does that mean I shouldn’t watch any economic indicators?

As mentioned, there are so many different economic indicators I could discuss, depending on what market you are trading. Purely technical traders often don’t pay attention to fundamentals at all as they make their trading decisions—they simply analyze the charts, and try to determine what the patterns on the charts are telling them may come next.

While there are probably hundreds of different pieces of data for dozens of different futures markets, I do feel if you are going to concentrate on trading a particular market, it’s useful to know which pieces of data are likely to have an impact on price on any given day. Even if you don’t want to dissect and analyze what a particular report means, you should know that it’s coming—and which reports tend to generate greater market activity. There are some benchmark reports that market participants will collectively focus on for each particular market. Get familiar with the ones that might impact the market you trade. For example, for the financial futures markets, such as the stock index futures, currency futures or Treasury futures, I will point out a just a few favorites I have seen time and again cause these markets to react.

Federal Open Market Committee Actions. The Federal Open Market Committee is the policy making arm of the Federal Reserve, the nation’s central bank. The FOMC has scheduled meetings throughout the year, where its board members influence the direction of interest rates. This is done mainly though manipulation of the federal funds rate, a short-term interbank lending rate, by tightening or easing the monetary supply. If the Fed is concerned about inflation, it might raise the short-term interest rate. In such a scenario, the stock market would likely decline because inflation lowers corporate profits and eats into consumer spending, and that impacts the price of shares. While that’s a classic reaction, sometimes the markets don’t always move in the direction you expect following a particular report. If the Fed is raising rates and the economy is incredibly strong and resilient, the market may keep chugging along to new highs. (Remember the boomtimes of the 90s?) Sometimes it depends on where we are in the economic cycle, so how the markets react to the data may take some thought. The point is, if you trade financials, don’t ignore the impact of the Fed!


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Consumer Price Index. The CPI measures inflation at the consumer price level. It’s important because we all know inflation has a big impact on spending habits that can ripple throughout the economy.

Producer Price Index. The PPI measures inflation at the producer, or wholesale, price level. It’s important to note that PPI and CPI don’t always perfectly match. At times, producers facing increasing costs don’t pass those price increases on to consumers.

Housing Starts and Building Permits. One-third or more of the economy is affected by the housing market. Think about it. Strength or weakness in the housing industry impacts commodities that go into building, such as lumber or copper. It also impacts employment in those and other industries including plumbers, construction workers, real estate agents, and mortgage brokers. And it has a big impact on consumer and commercial spending and investing.

Employment Report. This monthly report from the Bureau of Labor Statistics measures the amount of non-farm payroll jobs added to the economy each month, and the rate of the nation’s unemployment. This report can have a big impact on Fed policy actions, and the state of the economy at large.

Question: What’s the difference between price and yield in the interest rate market?

Since I’m discussing fundamental reports that impact financial futures, I’ll address another common question I get about the interest rate markets—the difference between the price of an instrument, and its yield. When we trade futures, we trade the price of the interest rate instrument, such as the five-year Treasury note, 10-year Treasury note or 30-year Treasury bond. Each instrument has a corresponding interest rate yield (typically higher for the longer-dated instruments), which moves inversely to its price. Why? When market interest rates rise, prices of existing interest rate instruments (those with fixed coupons) fall to bring the yield of older interest rate instruments into line with new issues offering the higher interest rates. On the flip side, when market interest rates fall, prices of existing interest rate instruments rise until the yield of older interest rate instruments are low enough to match the new issues offering the lower rates.

To put it in simple terms, the new cost of money today affects yesterday’s cost of money. If I give you more interest today than you were getting yesterday, the instrument you are holding is less valuable, so it would trade out at a lower cost.

Question: What do the terms intermarket and intramarket mean?

Intermarket means different markets, and as a trader, I view the relationship as moves within markets that might interact with each other, such as the 10-year Treasury note, 30-year Treasury bond, and Eurodollar, all interest rate instruments. I like to expand this definition even further into other markets I trade that may have a correlation with each other. The same fundamental factor may influence these inter-related markets, although sometimes in opposing directions. For example, gold is often seen as a safe-haven instrument for investors during times of inflation or economic uncertainty, and gold and currencies typically have an intermarket relationship. The price of gold typically rises as the U.S. dollar falls, and falls when the dollar rises.

Intramarket means the same market, such as old-crop, new-crop corn. Or, a March Treasury bond futures contract versus a June Treasury bond futures contract. The same fundamental factors are going to likely affect intramarket relationships in a similar fashion.

Question: If just trade one market and am strictly technical, do I need to worry about these intermarket relationships?

The same technical analysis techniques can be applied to almost any market. So some traders say you don’t need to worry about moves in different markets, and how they affect each other. They just watch the chart of the market they want to trade, without outside influences.

However, I say you should pay attention to other markets, even if you aren’t trading them. Sometimes, they make parallel, or opposing moves, based on the same fundamental factor. Furthering the gold example, I think it’s wise to be aware of what the dollar is doing if you trade gold. If the latest CPI reading, for example, points to increased inflation, I’ll look at my chart and analyze moves in these two markets. If I’m targeting a move higher in gold past a key resistance area, I’ll see if the dollar has broken key support as a confirmation of the trend. This is just one example. We can see many intermarket relationships, and they can even change. Right now, crude oil has had a strong intermarket relationship with a number of other markets, because the price of crude oil has such a large impact on so many areas of our economy.

Question: What chart or technical indicators are better to use?

There are many kinds of charts you can analyze and tools you can use, but to me, there is one no better than another. It’s really just about getting a solid understanding of something, whatever it is, and finding your edge. There are many types of tools and techniques, and they can be equally successful or unsuccessful for you. That’s why technical analysis is often called as much an art as a science. You might find you love candlestick analysis and want to learn it inside and out, but Gann theory, not so much. Learn the tools available, apply them to the markets, and see what resonates with you.

As a new trader, however, first and foremost you want to look for the trend. I’m sure you’ve heard the phrase, “the trend is your friend,” because finding and trading with the trend is so important, and going against it can be difficult and costly. You want to draw your trendlines to help you find and support and resistance points, which in turn help you to determine where to enter and exit trades. It’s important to note when the market breaks out of key support and resistance levels, because these breakouts can mark a new leg of the trend, or renewed strength, in either direction. Often when we see a breakout, old resistance can become new support as the market makes a new run to higher ground and a higher plateau, and the flip side, old support can become new resistance when the market takes a tumble. So identifying the trend, and finding support and resistance, are the first basic techniques to master.

Question: What does consolidation mean?

This is when the bulls and the bears start to fight each other so to speak. The market is fighting to establish a solid direction, or trend, and trade is typically confined within a narrow price range for a period of time. A sharp rally or downturn often is followed by a period of consolidation, as market participants decide how to position for the next move.

Question: What’s risk management, and why do I need it?

I often get questions about money management, and it is so important I can’t stress it enough. You aren’t always going to have winning trades, but if you can define your risk, you can survive. If you have no idea what you are willing to risk once you get in the market, you are already committed, you are already emotional, and it’s too late. I believe money management techniques are critical to long-term success in trading, no matter how you approach trading or which markets you trade. You don’t have to be a rocket scientist to develop a sound risk-management plan. Work with a professional if you need help developing one for yourself.

Question: How much should I risk on a trade?

Before you trade, you need to determine how much you can risk given the size of your account and your hoped-for-profit objective. Don’t risk $10,000 on one trade if you only have $10,000 in your account, no matter how right you think you are. That’s just common sense. I recommend allocating between 5 and 10 percent of your risk capital on any given trade. If you are a long-term trader and don’t trade very often, you can risk a little more, maybe up to 10 percent. If you are a swing-trader and trade a little more, you may want to risk somewhere around 5 percent. If you are day trader and are in and out of the market often, you may want to keep it to about 2 percent so you have enough capital to take the next opportunity that comes along, even if you have several losing trades in a row.

Question: What tools can help me with risk management?

There are a number of tools available to help you manage risk. As a technician, I use support and resistance points to help me set my risk and reward parameters. Setting stops based on chart patterns is one way to help define risk, and another is by using options. I won’t get into details about specific options strategies, but by using options, you can define your loss more specifically than with an outright futures position, and they can be used as a hedge against a futures position as well. Use of options as risk management tools tend to be more suitable if you are looking for a greater move over a longer time horizon (that is, if you are a swing trader or position trader). If you are a day trader looking for quick, explosive moves, use of a stop is more likely the better tool for you.

Question: How do I decide when to exit a trade?

Using technical analysis, I determine where I want to enter my trade, and what I’ve defined as acceptable risk. For example, I buy when the market hits a specific support point, and sell when it hits a specific resistance point. But my golden rule about getting out of trades doesn’t matter whether you make your decisions from fundamental, or technical factors. As soon as the reasons for entering the trade are no longer valid, and have changed, get out. If you are a fundamental trader and decide to sell S&P futures because you feel the Federal Reserve will raise interest rates, but the Fed doesn’t do so, get out. Your thought was wrong, and the environment has changed. If you see the S&P futures break key resistance, so you buy, but then the rally fails, get out. Don’t hope the market will come back. That’s discipline, and if you can’t exercise that type of discipline, you’ll be out of the game. On the other hand, if your trade is profitable, let it run until the fundamental conditions have changed, or until your charts are telling you the trend is changing, or headed for a change. If you cut your losses quickly but let your profitable trades ride, you don’t have to be right 100 percent of the time to be a successful trader.

These are just a few of the many, many questions I’ve had over the years about trading. I could go on and on! Please feel free to call me with any of your own.

You can hear market commentary from Lind-Waldock market strategists through our weekly Lind Plus Markets on the Move webinars, as well as online seminars on other topics of interest to traders. These interactive, live webinars are free to attend. Go to www.lind-waldock.com/events to sign up. Lind-Waldock also offers other educational resources to help your learn more about futures trading , including free simulated trading. Visit www.lind-waldock.com.

Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.

Futures trading involves substantial risk of loss and may not be suitable for all investors. © 2007 Lind-Waldock® a division of Man Financial Inc All Rights Reserved. Futures Brokers, Commodity Brokers and Online Futures Trading. 141 West Jackson Boulevard, Suite 1400-A, Chicago, IL 60604.


About Today's Author:

Jeffrey Friedman is a Senior Market Strategist with Lind Plus. He’s been involved in the futures industry for more than three decades, getting his start as a CBOT floor clerk in 1975, then as a spread research analyst for a group of independent floor traders. In 1981, he became a member of the Chicago Board of Trade and worked as both a local and a floor broker, trading for his own account and filling customer orders.

In his current role at Lind-Waldock, Jeff incorporates a mix of fundamental and technical analysis techniques tailored to specific markets and market conditions. He assists clients in developing a trading plan suitable to their individual interests, risk tolerance and resources. His approach is driven by the principles of capital preservation.

Jeff follows most of the major futures markets every day and provides timely information and assistance in formulating trading strategies. He provides daily commentary on Lind-Waldock’s technical analysis hotline, “Strictly Technical,” available to clients at the start of each trading day.

You can reach him via phone at 866-231-7811 or via email at jfriedman@lind-waldock.com.