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John Person Complete Guide to Technical Trading Tactics .pdf

Nome del file originale: John Person Complete Guide to Technical Trading Tactics.pdf
Titolo: John L. Person : A Complete Guide to Technical Trading Tactics™ √PDF √eBook ✔Download
Autore: How To Profit Using Pivot Points, Candlesticks and Other Indicators

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Guide to

Guide to
How to Profit Using Pivot
Points, Candlesticks &
Other Indicators








Introduction to Futures and Options:
Understanding the Mechanics


How the markets work, the elevator analogy, product for the times, important
terminology such as margin, contract specifications, and leverage


The Market Driver


Supply and demand issues, economic growth and productivity effects, major economic reports and their in role in market prices


Technical Analysis:
The Art of Charts


Western-style bar charts and key reversals, point-and-figure charts that focus only
on price, market profiling, price and time analysis


Candle Charts:
Lighting the Path


Enlightening charting technique and its colorfully named patterns—hammers,
stars, spinning tops, dojis, hanging man, and others—powerful reversal patterns,
reliable continuation patterns, key examples in the dollar and bonds




Chart Analysis:
Volume, Open Interest, Price Patterns


Volume and open interest rules for traders, M tops and W bottoms, trend lines,
measuring patterns, the head-and-shoulders, triangles, pennants and flags, diamonds, wedges, funnels, gaps, islands, rounded bottoms, oops signals, opening
range breakouts


Pivot Point Analysis:
A Powerful Weapon


The pivot point formula for target trading, calculating support and resistance levels, importance of multiple verification from several sources, the P3T trading technique, weekly and monthly charts and numbers, risk management techniques


Day-Trading, Swing Trading:
Acting on Analysis


Trading to bounce off target numbers, calling tops and bottoms, weekly chart
magnets, harami cross and other candle clues to market reversals, pivot points
save the day, lining up the stars, the verify-verify-verify approach


Technical Indicators:
Confirming Evidence


Moving averages and trends, simple rules with averages, tweaking and visualizing
MACD, stochastics, false signals, Gann’s key numbers, Fibonacci ratios and projections, time counts for cycles, Elliott wave and its clues


Market Sentiment:
What Traders Are Thinking


Getting a market consensus from contrary opinion, Commitments of Traders
reports, margin rate changes, Market Vane Bullish Consensus report, put-to-call
ratios, volatility index (VIX), when the boat is tipping over, media effect

CHAPTER 10 Order Placement:
Executing the Plan


Importance of getting an order right, online platform concerns, impact of market
conditions on orders, 14 top order entry selections you need to know, orders in
after-hours trading, spreading concepts



CHAPTER 11 The Mental Game:
Inside the Trader


Conquering fear, learning discipline, improving confidence, suggestions for success, I’ll-think-about-it syndrome, the paper trader, fear and greed factors, becoming a specialist, setting up an investment diary, setting a positive mind frame,
dealing with adrenaline, establishing goals, positive affirmations, stress relief
techniques, rewarding success to build success

CHAPTER 12 The Tactical Trader:
Tips and Techniques That Work


Pyramiding approaches, scale trading, stop reversals, breakouts, momentum trading, the Friday 10:30 a.m. rule, stop placement near a magnet, trading multiple

CHAPTER 13 Options:
A Primer


What options are and how to use them with futures, simple puts and calls,
options premiums, the Greeks, comparison shopping, strangles and straddles,
eight top option spreads, delta neutral techniques

CHAPTER 14 Closing Bell:
My Top 10 List


What the experts suggest, top 10 trading thoughts, measuring success








he purpose of this book is to share some of the tips, techniques, and
observations that have worked for me and other highly successful
traders. After nearly 23 years as a registered broker in the futures and
options field, I have come to know quite a few successful traders and have
personally made many successful trades. I have also experienced my share
of disasters and have known traders and investors who were doomed for
permanent failure. Therefore, I am writing this book to help the new individual investor understand the mechanics of the markets and to serve as a
refresher for the seasoned veteran trader.
Most of the trade examples demonstrated in this book were direct trade
recommendations from either The Bottom Line Financial and Futures
Weekly Newsletter or those that appeared in the daily Dow report provided
through the Chicago Board of Trade web site and at www.nationalfutures
.com. Rather than demonstrating just one methodology of trading tactics
using pivot point analysis, I wanted to show through various techniques how
you can implement these calculations with other methods and indicators.
Much of what I have learned over the course of 23 years in the industry did
come from hard work and, I must admit, being around the right people at the
right time. I do not want you to abandon your knowledge of traditional technical analysis techniques. I would just like you to be open to integrating the
numbers to help you confirm, validate, and identify entry and exit points
when trading.
I also want to relay the message that mathematically calculated support
and resistance numbers, or pivot points, work on different markets and
should be derived from different time frames—not only from a daily basis,
but also from a weekly and monthly time frame.
In addition, as most of the readers either know or will find out, trading
is also a combination of strong emotional and personal characteristics.
Through my experience and observations, I want to share and explain what





works and what does not but, more important, to disclose why things go
wrong when they do for those who failed. I believe it is important to take an
inventory, so to speak, when things go right to capitalize on that experience
by examining what you did so the results can be repeated. It is just as important to examine what went wrong so you can learn from the experience. By sharing with you the experiences and techniques that I and other
professional traders have learned, the hope is that you will benefit and become a more profitable trader.
I firmly believe that traders from all different levels of experience will
benefit from the information contained in this book, whether it is actually
gaining a new understanding or a new technique or refreshing, reviewing,
or reviving your memory about tactics, strategies, or trading techniques
that an advanced trader may have forgotten.
My professional history may explain my qualifications for writing this
book. I started in this business as a runner on the floor of the Chicago Mercantile Exchange in 1979. To illustrate a reference point in time, the Dow
Jones Industrial Average was near the 900 level. The S&P 500 Index futures
contract did not even exist back then. I became a registered commodity
broker in 1982 and worked up through the ranks in the industry as I was
studying economics at Loyola University. The head of the research department at the firm where I worked was George C. Lane. He, of course, is
credited with developing the oscillator system known as stochastics. He
was the first boss who tutored me in the art of technical analysis. Little did
I know at that time that a true master of technical analysis was going to be
responsible for helping to create the intrigue, financial rewards, and passion for the futures industry that I have had throughout all these years.
Granted, there were other individuals who had an influence on my career. Jack F., an old member of the Chicago Board of Trade, helped me understand the importance of moving averages and the aspect of long-term
charts. Back in 1985 and 1986 in what I call the great bond market boom, he
was instrumental in helping me understand how to ride a strong trending
market. In 1986, I captured what I call a winning tidal wave bull market run
that remains legendary to this day for those who were on board with me, as
well as friends who invested and knew me well.
Another broker at a firm where I worked taught me this strange and
unique method of plotting unconventional trend lines to predict price and
time coordination. Harry A. was his name and this guy would tell you on a
Monday that at 11:40 a.m. Wednesday the high in bonds would be 7812⁄32.
Come Wednesday at 11:45 a.m. or so, the high was 7811⁄32, and I would watch
the price take a disastrous plummet. His method, as I later found out, was
based on Drummond geometry.



I had the privilege to work with a former chairman of the Chicago
Board of Trade, Bill Mallers Sr., who was always looking for a new system.
His thirst for achievement and passion for the markets amazed me. Another
man in the office who worked for Bill Sr. was a fairly quiet, yet confident,
guy. He always had a cigar stub in his mouth—never did smoke but just
chewed on them. He sat near me and time after time would overhear my
recommendations to clients, in particular my points of support and resistance. Almost on a daily basis he had the same target numbers, usually
within a point or tick of mine. That is when we discovered we were doing
the same thing. The amazing thing was he claimed to be a direct student of
Charles Drummond.
I was also fortunate to have been introduced to another fascinating
man, Dan Gramza, an instructor for several futures exchanges and firms
worldwide. His understanding of the market and the relationship between
time, price, and volume is incredible. His teaching also included a wonderful tutoring in candle charting. When I discovered that, he humbly mentioned that he knew Steve Nison and “helped” write some of Steve’s first
book. When I got home, I immediately searched for the book in the storage
box and, sure enough, there it was in the acknowledgment section on page
IV. Not only was Dan mentioned in one of the best books on the basics of
candle charting, in my opinion, he helped write chapter 8 in Steve’s book.
My experience has ranged from learning stochastics from the creator
of the indicator, moving averages from a famous floor trader and options
from my own experience, Drummond geometry from two different fascinating people at two different times in my career, pivot point analysis, and
then candle charting techniques from what I would call a master.
In March 2003 I started hosting a radio program titled, The Personal Investment Hour. The format was to invite expert traders and analysts to
share with listeners who they were and what they do to trade successfully.
My guests have included John Murphy, Martin Pring, John Bollinger, Victor
Niederhoffer, Gerald Appel, Linda Bradford Raschke, Larry Williams, and a
fabulous roll call of other top experts. Most guests were thrilled to come on
and share their story and methods. Some of the contents of those interviews are mentioned in this book as well. In fact, the interviews were
recorded and archived on my web site,, where
anyone can go to listen to them.
By writing this book, I can share with you how and what I do to produce
the analysis that goes out every week in The Bottom Line Financial and
Futures Newsletter. I believe my experience in the industry and the techniques that I have developed can be instrumental in helping you to become
a better trader. I believe that you can successfully learn to better integrate



the two elements of market analysis: time and price. The elements that I
have focused on from the technical side are:
• Pivot points, a leading price predictor that is based on price points
using different time frames.
• Cycle analysis, which deals with predicting market turning points based
on time.
• Candle chart patterns, which are based on price relationships between
the open, high, low, and close and past chart points such as old highs
or lows.
• Fibonacci ratio corrections and extension studies, which are based on
past price points.
Other studies such as volume are used to gauge the level of participation
and to help uncover the strength or weakness of a market trend.
The last—and maybe the most—important aspect of trading that this
book covers is evaluating the psychological makeup of traders and providing exercises that can help those who are having a rough period overcome
their problems. Learning who you are and how you react to market conditions is a vital aspect of trading.
I hope that reading this book will help you have a better understanding
of what it takes to trade and to broaden your horizons in investing in the futures and options market. More important, I want you to know how to learn
to do it on your own. Industry experts agree that about 80 percent of the
people who trade lose. With those odds against you, you need all the help
you can get! Individual speculators need to know that it is a rewarding adventure as long as they can make it against the markets and their biggest
competitor, every other trader. As a zero-sum game, for every loser there is
a winner in futures trading. Or another way to think about it, perhaps, is
that 20 traders are taking the money of 80 other traders.
If you are going to trade successfully, you need to understand that it requires hard work and, above all, to think of trading as a business. As you
read this book, I hope you learn that you do not need to have an IQ of 160
or be a mathematician or possess superhuman skills to be successful. What
you do need to have is a fascination for this business, patience, discipline,
a trading plan, identification of what type of trader you are, risk capital, and
the desire to improve your financial life.
Through the development of technology and the Internet, more information is accessible today for the individual speculator than ever before. I
sincerely believe a knowledgeable and educated investor is a better trader.



So if you are trading or are getting ready to trade, try to work at continually learning what is available to you. Cutting-edge technology will continue to offer more powerful and helpful trading tools to individual traders.
It is up to you to learn how to use them to your advantage. I hope that you
will benefit from the tips and techniques that are mentioned in these pages
and certainly hope that you can apply them successfully in your trading.
Palm Beach, Florida
March 2004


riting requires intense devotion and discipline; I now have a new
sense of respect for anyone who has ever written any books or
published material, especially on the subject of technical analysis.
I have many people to thank—those who were indirectly responsible and
influential in my education throughout the years and, of course, my family,
especially my wife, Mary, who also tolerated my perseverance for finishing
this book at the expense of ignoring her and asking too many questions
when I had computer problems.
Mom, I know you wanted a lawyer in the family; instead you got a futures trader. My son, John Paul, who decided not to get in the investment
business; instead, he followed the entrepreneurial spirit and opened his
own chain of cell phone stores. There is still a chance to convert him back
to the investment world: He likes my stock picks!
Special thanks to the Friday night “wanders” group, the best support
group of friends one could ever have. Those I wish to mention directly: Lan
Turner from Gecko Software, Stuart Unger, Barry Isaacson, Cheryl Fitzpatrick, Rory Obractin, and Jonathan W. Dean from FutureSource; Dan
Gramza for inviting me to his class and taking my calls; Barbara Schmidt
Bailey and Ted Doukas from the Chicago Board of Trade; and James
Mooney, president of Infinity Brokerage Services.
The more analysts and authors I met, the more I found how truly fortunate I was in having Pamela van Giessen of John Wiley & Sons as my editorial director. Thank you, Pam! My special thanks go to Darrell Jobman,
who was directly responsible for orchestrating and directing me through
the whole process of this project and directly responsible for helping to get
this material organized and published.


J. L. P.


Guide to


to Futures
and Options
Understanding the Mechanics

Success is turning knowledge into positive action.
Thinking is easy, acting is difficult, and to put
one’s thoughts into action is the most difficult thing
in the world.
—Johann Wolfgang von Goethe

oethe could have been referring to paper trading versus the act of actually trading when he wrote the phrase above. Trading is exactly that:
putting your thoughts or convictions about a price move into action
by entering an order and placing money at risk.
Investing is a totally different ball game. This book is about trading. The
purpose of trading is to turn over or buy and sell (sell and buy) to build cash
in an account by capitalizing on changes in price. It is not about acquiring
and holding assets or property.
Futures trading is becoming more attractive than ever before as investors transfer their knowledge and trading skills from the stock market
boom of the late 1990s to more active markets where the idea of creating
wealth is still alive. As the equity markets became consumed by the bear
market mentality liquidation phase, investors with knowledge of technical analysis and computer skills flocked to open futures accounts to trade
e-mini S&P 500 and e-mini Nasdaq 100 index futures.
Stock market firms and brokers have developed futures divisions, and
day-trading education experts have crawled out of the woodwork to teach investors the art of day trading those products. Some of the numerous quality
instructors come with a very high tuition cost; others are not so expensive.





Most likely, learning about trading at a reasonable price is why you are
reading this book. However, reading this book alone will not guarantee that
you will succeed in trading. You need to read this book, practice its principles, and continue your trading education, realizing that the biggest obstacle
in trading is what is between your left and right ears. I believe the techniques
in this book are excellent strategies, and I hope you will apply and benefit
from them. Teaching someone to become a successful trader and letting
them experience the power of financial rewards is a satisfying and rewarding pursuit.
As investors look for markets beyond stocks or mutual funds in which to
put their money, they will find a whole new world out there with different
products to trade, among them futures. You may be among those investors
who are afraid of and concerned about trading futures because of what you
heard about them in the past. There are good reasons for being nervous about
treading into any new market. But consider the scandals that have plagued
Wall Street in the post-bubble era and may continue for some time. As history
shows, there have been countless scandals on Wall Street in the past, and
there almost certainly will be more in the future. So-called traditional investing in stocks is not immune to risk and has its own set of problems.
The question is: Will confidence in America’s corporate leadership return
sooner rather than later? Stock ownership is at the highest level per capita
in America’s history. More investors and private traders participate in the
markets than ever before. In addition to stocks and mutual funds, there are
a host of stock-related derivative products—exchange-traded funds such as
QQQs, options such as the OEX, and many, many others including a relatively new and spectacular market development called single stock futures.
The price direction of equities and all of these derivative instruments boils
down to what will happen to the underlying forces of earnings and growth.
Here is a brief story that may shed light on Americans’ changing viewpoint about investing. I was giving a seminar on the futures markets to an
investment club. One older gentleman said his money was safe in the bank,
and he wouldn’t give his money to the stock market again.
I asked, “Why do you feel that way?”
He responded, “They are all crooks!”
“Well, if you think like that, why are you at a futures seminar?” I asked.
“I always thought they were risky, but now I want to learn for myself,”
he replied.
“Futures trading is risky,” I agreed, “but what gave you the impression
not to open a futures account before?”
“My stock broker told me not to trade commodities, that I would lose
my shirt,” he said. “So I kept buying the stocks he recommended, and, instead, I lost my shirt with him.”

Trading Mentality


Not a happy story, but the amazing development is that the gentleman
is getting back on the horse after falling off, this time getting his own education and finding out for himself whether futures are for him.
This book is designed for people like him and for the more experienced
technical trader as well. If you had a similar experience, then keep reading
and studying and you will continue to increase your knowledge and competence. With that, you will gain confidence. The more knowledge and information you have about a subject, the better you will become in dealing
with it. As we all know, knowledge is power.
Every investor should know that trading is like riding an elevator. You
get on if you want to go up and then get out once you are where you want
to be. If you want to go up but then realize that you are going down instead,
bail out. Get off the elevator and get back on another ride going up. Risk
management and turnover are the keys to successful trading.

Most new investors are not familiar with trading the short side of the market.
I have listened to many novices say that they have a hard time comprehending how to sell something they do not even own. I always tell them that even
if they buy a futures contract to go long, they are not going to own anything
(except in rare instances where they may take actual delivery of some physical commodities).
All futures traders are doing is speculating on the direction of prices on
a given product during a given time period. If they are right, they get rewarded; if they are wrong, of course, they get penalized. Remember the elevator analogy. If a building has 100 floors and you are on the 50th floor, you
can play a guessing game to see if the elevator goes up or down and by how
many floors. You can take the ride, but you don’t have to own the elevator
to do so.
The principle of trading is a very simple concept although we, as humans, tend to make it quite complicated, especially those who have a hard
time comprehending selling short. Trading is just a matter of interested parties coming together and speculating whether the price of a specific commodity is going to go up or down. It is that simple.
Let’s say Bill believes the price of commodity XYZ is going up, so he
buys. A second trader, Pete, believes the price is going down, so he sells
short. One could win, one could lose. Or, believe it or not, both Bill and Pete
can be right and make money during the same day with their opposite positions. Similarly, both could also lose within the same trading day doing
the exact opposite trade at the same time. It happens all the time. Volatility



is the reason. Get to know that term as well as whipsaw, choppy, erratic
market behavior, and other terms used in connection with volatility.
The market’s behavior reflects the emotional condition of those who are
doing the trading. The market is the by-product of those who use it. Sometimes it seems like a jungle. It can be financially rewarding and exciting like
discovering a wealth of mineral deposits in a hidden cavern behind thick
brush. It can also be like enjoying the beauty and splendor of a sunset off
the coast of Florida with the sun’s light descending on the low clouds as
palm trees sway in the breeze. But it can also provide some of the scariest
and most financially dangerous adventures you will ever experience.
Trading will probably test your emotional strength and psyche. It will be
the ultimate financial, emotional, and intellectual challenge you will ever encounter. Fear, doubt, complacency, greed, anxiety, excitement, false pride—
all can interfere with rational and intellectual thoughts. It is those feelings
that create the jungle, and you may need help to overcome that jungle of
emotion. Conquer those feelings and you may find the holy grail of trading:
a confident winning attitude.
Reading this book will give you the knowledge necessary to improve
your life as a trader. You will be taught to take the emotion out of trading and
to develop a method or trading plan. Remember, “Those who fail to plan, plan
to fail.” I have devoted a chapter to the mental aspect of trading (Chapter 11)
because I believe about 80 percent of successful trading is based on emotional makeup. The way to increase your confidence and competence levels
is through knowledge, and that comes from learning solutions to problems
and then applying or executing what you learn.

As you learn different trading styles, remember this key concept: Futures are
a trading vehicle and not—I repeat, not—a buy-and-hold, long-term investment platform. Do not try to dictate or get married to an idea about the direction you think the market should go. This approach can lead to financial
donations to other traders’ wealth, to an increase in your knowledge about
your brokerage firm’s money wire transaction process, and, worse yet, to getting wiped out.
You need to work at this business. You need to manage and maintain
your positions and monitor price action. Game plans need to be established,
and you will need to be flexible and quick to act. Access and communication
to stay in touch with the market is important when you are trading.
Futures trading should be used to make money on a price movement. It
should not be a personal vendetta, trying to prove that you are right in your
opinion of what the market should do. That outlook is why there are all kinds

Getting Technical


of clichés about taking profits. For instance, “A profit is a profit, no matter
how small.” That is a great line, but let’s define “small profit.” Coming to this
business to risk thousands of dollars to make a hundred dollars or so isn’t
the way this trading environment should be used.
Another old saying describes someone who takes small profits and lets
big losers ride: “Eating like a bird and crapping like an elephant.” That is the
essence of a habit you don’t want. If this is a syndrome that you fall into,
Chapter 11 offers exercises to help you work through it. If you catch yourself
getting into that habit, stop trading. Try not to get used to taking small profits constantly and letting losses get large before taking them. You need to
develop good discipline and strong emotional traits. Otherwise, fear of losing
will hinder your performance.
Think about this: If trading were easy and such a sure thing, why would
you have to sign all of those disclaimers about how dangerous it is when you
fill out an account application at a brokerage firm?
So far I have mentioned buying, selling, winning, losing, and human emotions, and I have not yet covered a single aspect of technical analysis. This
approach to the subject reflects my belief about what I consider the most
important aspect of trading: your mental and emotional capacity.

Technical analysis is the study of a market’s price data, which is created by
the emotions of the participants. Price reflects the current or anticipated
value of a market from a supply and demand perspective. Price is the true
and absolute reflection of value, as perceived by the various market participants at a particular point in time.
There are a number of different forms of analysis. This book will go
into further detail on most aspects of technical analysis, but my focus is on
market reversals incorporating pivot point analysis with other methods to
nail down time and price predictions.
All traders have access to four common denominators: open, high, low,
and closing price. How you analyze, interpret, and act on the information
available is what gives you a trading style that differentiates you from other
traders. Successful traders interpret correctly and act swiftly. There are five
business days in every week and usually four weeks in every month. One day
within a month will usually mark a price high, another day will generally mark
a low, and the market will close somewhere between those points. Those
facts define the monthly range. The successful trader does not consistently
make a habit of buying the high of the range or selling the low of the range.
But before jumping ahead of ourselves into subjects covered later in the
book, we need to review what the futures markets are all about. Seasoned



traders may be able to skip over the next sections, but those new to futures
should read them carefully because they contain important concepts and
terminology that make futures different from most other markets.

For futures traders, the choice of products varies from the traditional to the
exciting new trading vehicles now available. Everyone can relate to many
of these markets that you use every day, from energy products such as crude
oil or natural gas to agricultural markets such as meats, grains, and the socalled softs (coffee, sugar, cocoa). Prices are dictated by supply and demand
functions that often are affected by weather.
In addition to supply/demand influences, futures markets may provide
a safe-haven security function. Precious metals such as gold may start to increase in price as investors on a global scale believe it is necessary to hold
on to hard assets instead of paper assets in times of political tension or
because they fear potential inflation resulting from the massive liquidity
pumped into the global economy from 2001 through 2003. Financial instruments such as Treasury notes and bonds and currencies are also popular
trading vehicles.
In short, diversified products in all of these areas are available to futures
traders and provide advantages in liquidity and leverage. Many of these markets also offer direct electronic access to traders. As long as there are products subject to supply/demand and price fluctuations that carry an element
of risk, there will be a role for futures in the business world.

Many people, including traders, refer to commodities and futures as one and
the same thing. To clarify that point first, the term commodities means an
actual physical product such as corn, wheat, soybeans, cattle, gold, coffee,
crude oil, cotton, and the like. The term futures refers to the instrument or
the contract that is actually traded on these underlying products. Futures
contracts have set standards for quantity, quality, financial requirements, and
delivery points, if any (many futures contracts have cash-settlement provisions so there is no delivery).
As the years have passed, futures contracts have been developed for new
“commodities” such as foreign currencies and a number of financial instruments including interest rate products such as Treasury bonds and notes,
stock indexes such as the S&P 500 index and Dow Jones Industrial Average,

The Futures Instrument


and, most recently, an innovative derivative product called single stock
Unlike equities, where stocks are quoted in dollars per share, different
commodities have different contract values and different point values. The
table of contract specifications for major U.S. futures markets (Table 1.1)
lists the symbols and sizes of various futures contracts. For example, the
contract size for corn is 5,000 bushels. If the value of one bushel is, say, $2.00,
then the overall contract value is $10,000. The full-size S&P 500 index futures
contract has a value of $250 times the index. If the index is at, say, 1,000, the
value of the contract is $250,000, considerably larger than the value of the
corn contract.
Exchanges require a good-faith deposit—usually called margin,
although it does not have the same meaning as margin in stocks—to play
the game. For most futures contracts, you usually need to put up only 3 percent to 10 percent of the total contract value to trade. On the one hand, corn
may have an initial margin requirement of $500 to $600—about 5 percent of
the contract’s value—with a maintenance margin of $300. For that amount
of money, you control 5,000 bushels of corn and can go long, speculating that
prices will climb in the future, or sell short, speculating that the price will
decline. The more volatile S&P contract, on the other hand, has a margin requirement closer to 7 percent or 8 percent or $18,000 to $20,000. The amount
of money required to trade a contract may dictate what you trade if you have
a small account.
It has been argued that physical commodity products will find a fair
value or an absolute value when they reach certain lows based on historical price comparisons and will never go to zero due to laws of supply and
demand (Economics 101). Unlike stocks, commodities do not declare bankruptcy or go out of business.
The reason futures will always have some value is because they do not
exist solely for traders to bet on price movement. Producers and end users
are also major participants in most futures markets as they use futures to
reduce risk from adverse changes in price and to discover the current fair
value for products they have to buy or sell to stay in business. Traders in
this category are referred to as commercials or hedgers.
You probably are in a second group: the individual speculator trying to
capitalize on price swings created by the up and down forces in the marketplace. You may be trading from your home as a business or on the trading
floor or trading as a sideline.
A third category of futures traders includes the large speculators or fund
managers who pool investors’ money together. These are sometimes referred
to collectively as the commodity funds.
One advantage of futures trading is that the government gives you
an idea what each of these groups of traders is doing each week in the




Major U.S. Futures Contract Specifications

Futures Contract

Contract Size

Contract Monthsb Exchangec

Interest Rates
Eurodollar, 90-day
Treasury bills, 90-day
Fed funds, 30-day
Treasury notes, 2-year
Treasury notes, 5-year
Treasury notes, 10-year
Treasury bonds, 30-year
Municipal bonds

$ 200,000
$ 100,000
$ 100,000
$ 100,000
$ 100,000

H, M, U, Z
H, M, U, Z
All months
All months
H, M, U, Z
H, M, U, Z
H, M, U, Z
H, M, U, Z
H, M, U, Z


S&P 500 Stock Index
E-Mini S&P 500 Index
Dow Jones Industrial Avg.
Mini-sized Dow
NYSE Composite Index
Mini-Value Line Index
Nikkei 225 Stock Avg.
Euro-top 100 Stock Index
FT-SE 100 Stock Index
S&P Mid-Cap 400 Index
CRB Futures Index
Goldman Sachs Com. Index

$ 50
$ 10
$ 5
$ 5
$ 50

H, M, U, Z
H, M, U, Z
H, M, U, Z
H, M, U, Z
H, M, U, Z
H, M, U, Z
H, M, U, Z
H, M, U, Z
H, M, U, Z
H, M, U, Z
F, G, J, M, Q, X
All months


Australian dollar
British pound
Canadian dollar
Euro currency
French franc
Japanese yen
Mexican peso
Swiss franc
U.S. Dollar Index

100,000 AD
62,500 BP
100,000 CD
125,000 Euros
500,000 FF
12,500,000 JY
500,000 MP
125,000 SF
$100 × index





100 troy oz.
5,000 troy oz.
25,000 lbs.
50 troy oz.
100 troy oz.
44,000 lb.
33.2 troy oz.
1,000 troy oz.











The Futures Instrument




Futures Contract

Contract Size

Contract Monthsb Exchangec


Crude oil
Heating oil
Unleaded gasoline
Natural gas

1,000 bbl.
42,000 gal.
42,000 gal.
10,000 MBTU


Wheat, soft winter

5,000 bu.
5,000 bu.
5,000 bu.



Soybean oil

60,000 lb.


Soybean meal

100 tons


Wheat, hard red winter
Wheat, spring

5,000 bu.
5,000 bu.
5,000 bu.

H, K, N, U, Z
H, K, N, U, Z
F, H, K, N, Q,
U, X
F, H, K, N, Q,
U, V, Z
F, H, K, N, Q,
U, V, Z
H, K, N, U, Z
H, K, N, U, Z
H, K, N, U, Z


Live cattle
Feeder cattle

40,000 lb.
50,000 lb.



Lean hogs

40,000 lb.


Frozen pork bellies

40,000 lb.

G, J, M, Q, V, Z
F, H, J, K, Q,
U, V, X
G, J, M, N, Q,
V, Z
G, H, K, N, Q

37,500 lb.
112,000 lb.
10 metric tons
50,000 lb.
15,000 lb.
110,000 bd. ft.

H, K, N, U, Z
F, H, K, N, V
H, K, N, U, Z
All months
F, H, K, N, U, X
F, H, K, N, U, X


Coffee “C”
Sugar #11 (world)
Frozen orange juice
Lumber, random length





Exchange symbols; data vendors may use other symbols.


Contract months:
F = January
G = February
H = March
J = April
K = May
M = June


N = July
Q = August
U = September
V = October
X = November
Z = December

Exchange abbreviations:
CBOT = Chicago Board of Trade
= Chicago Mercantile Exchange
KCBOT = Kansas City Board of Trade
= Minneapolis Grain Exchange
NYBOT = New York Board of Trade
NYMEX = New York Mercantile Exchange



Commodity Futures Trading Commission’s Commitments of Traders report.
I cover this subject in more detail later in the book, but the report is sort of
like getting the inside scoop on who is doing what—like a delayed report on
legalized insider trading.

Exchanges provide the contracts and the facility (trading pit or computer)
where buyers and sellers can come together to trade, all monitored carefully
by the exchange under the oversight of federal regulators to preserve the integrity of the market. Futures exchanges make a major point of providing a
level playing field for all participants and ensuring that the integrity and financial soundness of the marketplace remains intact. After all, if you have a
winning trade and want to take your profits, you need to trust that the money
you earned and deserve will be available. The futures industry is built on the
principle of integrity.
A few years ago the Chicago Board of Trade celebrated its 150th anniversary. Originally established as a centralized marketplace for grain trading, it has become known for its financial products and is one of the highest
volume exchanges in the world. The Chicago Mercantile Exchange, also
mostly known today for its financial products, and the New York futures exchanges also trace their roots to the 19th century. So futures markets have
been around for a long time and will continue to exist in the future.
Just as the Chicago Mercantile Exchange moved from trading eggs and
butter to products such as currencies, the Eurodollar, and stock indexes, exchanges are constantly evolving to meet the changing needs of consumers
and producers, adding new and exciting trading vehicles to the futures industry. For example, milk producers saw a need to hedge their risk against
often-volatile price movement in the cash market as values move from an extreme low to an extreme high. The Chicago Mercantile Exchange recognized
the dairy industry’s needs and created a marketplace for participants to
hedge their production or purchase needs. Major corporations such as Kraft
Foods can now use futures to hedge against losses in the cash market.

Futures have a number of features that require more attention, beginning
with the concept of margin. As previously mentioned, margin in futures is
really a security deposit or performance bond.

Digging into Futures


Typically, only a small fraction of the contract value (usually 3–10 percent)
is required as a security deposit. With such a small deposit, it takes only a
small price move to produce a big percentage return, providing the power
of leverage for which futures are known.
Exchanges set the minimum performance bond requirements for each
contract and can change those requirements without notice, depending on
market conditions. Brokerage firms may increase the amount of money required beyond what the exchange has set if additional protection is deemed
necessary. Sometimes this is done if volatility or price swings are larger than
normal and the firm believes clients are at more risk than usual. For example, if the Federal Reserve makes a sudden interest rate adjustment, the market may panic, causing wild price moves. These volatile price fluctuations
may be the basis for a decision that the amount of money required to trade
should go up (or down) significantly at a moment’s notice.
Although brokerage firms can require more than a minimum performance bond, they cannot lower the amount below the minimum requirements that the exchanges have set. Most trading firms post their margin
requirements on their web sites. For exact updates, you can always contact
the exchanges for quick access to current information.
The current system used in the industry is known as SPAN margining—
Standard Portfolio Analysis of Risk System, developed by the Chicago Mercantile Exchange in 1988. Basically, it is a computer-generated calculation
that takes into account a trader’s total position to help determine the risk
associated with that position. This position could include strictly futures or
could involve an intricate options and futures strategy.
Margin and leverage give futures an advantage over other investment
instruments, but it is also a two-edge sword. During an adverse price move
against your position, the concept of leverage can turn into a bad situation
as losses can grow exponentially. Overleveraged positions and undercapitalized investors do get blown out, that is, positions and accounts can be liquidated with large losses and sometimes can leave large debits. However,
traders do have control over leverage. By simply adding funds to the account
to match the full value of the contracts you are trading, you can set up a situation where you no longer have investment leverage.
Within the system of margin, you should be familiar with two terms: initial margin and maintenance margin. Initial margin is the amount of money
you must have in your account to establish a futures position. If the market
moves against your position and the amount in your account drops below the
maintenance margin, you will get a margin call and must replenish your account to the initial margin level immediately to maintain your position.
We can illustrate the margin system using coffee futures. With coffee
futures trading around 60–65 cents a pound in 2003, the New York Board of



Trade’s initial margin requirement was about $1,700 and the maintenance
margin was $1,200. Based on a contract of 37,500 pounds and a price of 60
cents a pound, the total contract value was $22,500, putting the initial margin at about 7.5 percent of the contract’s value. If the price of coffee futures
goes up just 2 cents a pound, you have a gain of $750 or a return of about 44
percent on your initial margin money. However, if the price of coffee drops
2 cents a pound—not an unusual occurrence—you have a loss of $750 or
44 percent.
Some traders think they are required to have $1,700 plus $1,200 or a
total of $2,900 in their account to trade one coffee futures position. This is
not so. The rules of margin are that you need at least $1,700 in your account
to enter a coffee position. If your account balance drops below $1,200 at
any time, as it would with a 2-cent price decline, then you may receive a request to send in more money to get your account balance back to the original $1,700 level.
When a margin call is generated, it is advisable to discuss the situation
with your broker/trading advisor. From a regulatory standpoint, margin calls
must be discussed with the client and met as soon as possible. Generally,
clients are given a reasonable time to meet a margin call, depending on the
amount of money involved and the nature of the situation. Brokerage firms
have the right and the obligation to ensure the financial integrity of the marketplace and, therefore, may liquidate your positions to ensure that your account is restored to the proper margin requirements. Thus, it is important
to stay in tune with the markets and in touch with your broker when you
are holding positions.
There are two other ways to meet a margin call: (1) You may liquidate
the position at a loss or (2) the market may make a reversal, trading back
in your favor and taking you off margin call status.
The open trade equity in your account is credited or debited each day
as the settlement price fluctuates. This futures industry practice is called
marked to market. Traders often do not regard a setback as a loss until they
are out of the market, and they are only looking at a so-called paper profit
until they close out a winning position. It is a good idea to have excess capital in your account beyond what is required. I recommend having at least
50 percent more than the initial margin requirement for each position you
plan to take as a longer-term trade. For day traders, maintenance margin is
Futures contracts often involve large quantities of product with a fraction of the total contract value needed as a good-faith deposit. Not many people have $200,000 in cash to purchase a home, so they apply for a mortgage
and put 3 percent to maybe 20 percent down. But buying a home and trading
futures aren’t the same because of the leverage factor, and that is why options have become extremely popular since the early 1990s.

Contract Specifications


Investors who buy options have a right, but not an obligation, to fulfill
the terms of an options contract at a specific strike price. They can buy calls
to take advantage of price increases or buy puts to take advantage of price
decreases. The risk in buying options is limited to the initial premium paid
to acquire the option plus the commission and transaction fees associated
with the transaction; that means no margin calls in the event of a short-term
adverse price move. Simply stated, option buyers can enjoy staying power
and a predetermined risk level.
However, buying options is limited to a certain time period, and if the
market does not move enough in your direction in that prescribed period of
time, your entire premium or investment will be lost.
Chapter 13 is devoted to a comprehensive description of trading in options and the logical approach for understanding the terms and uses of different strategies.

In addition to the margin/security deposit difference, futures contracts have
several other features that make them different from equities, as Table 1.1
indicates. Futures come in different contract sizes and expire in specific
months. Equities all are priced on a uniform per-share basis, and they do not
expire (although a company may go out of business, which could cause your
investment to “expire”). Stocks may also have splits and reverse splits, and
some even pay dividends.
With equities, you can maintain a long-term position indefinitely. With
futures, you can also have a long-term position, but that will require that you
roll over from one contract to the next, liquidating your holding in an expiring contract and establishing a new position in a contract month that is
further away.
Novice traders and even traders coming off an exchange floor to trade
from a computer need to realize that different futures markets trade in different contract months, at different times of the day, and at different exchanges. In stocks, you have one symbol for Intel (INTC) or IBM (IBM) or
every other individual stock. In futures, a June contract for Japanese yen is
not the same as a September Japanese yen contract, for example, and they
have different symbols.
First, you need to know the symbol for the market you want to trade—
CL for crude oil, for example. Most quote vendors use the same symbols as
they are pretty much a universal language in the futures industry. However,
some vendors use the symbol CC instead of CO for cocoa or SU instead of
SB for sugar. The mini-sized Dow contract may be YJ, YM, ZJ, or some other



symbol specific to a data service or brokerage firm. Most applications have
a menu of symbols so you can look up the quotes or charts you want.
Second, you need to know the symbols for each month. This can be
somewhat confusing, especially to newcomers. The list of symbols for each
contract month is shown at the bottom of Table 1.1. Notice that March is
the only month that even contains the month’s symbol, H, as a letter in the
name of the contract month. The trickiness in properly identifying a futures contract is one reason new traders find futures trading more complicated than equity trading.
It can lead to a hazardous situation when you are rolling out of a contract that has been trading for a while and switching to a new one. For example, if you have been trading a June contract and have to shift to the
September contract as the June contract expires, you may still be in the
habit of using June. When placing orders, a slip in identifying a contract can
create problems and cost you money. Placing an order for a June contract
when you really mean to trade the September contract can easily happen in
futures trading if you get careless. There is a window of time when the
June contract will still be trading but not actively as most of the trading activity shifts into the next month. For commodities, that time period is between the first notice day and the last trading day for a contract. Orders will
still be accepted for the expiring month in that time frame, and it will be up
to you to cover your error if your order gets you into the wrong contract
month. (Note: The trading tactics section in Chapter 12 provides a technique that some big traders and floor professionals use as first notice day
approaches. It may benefit you to be aware of the first notice day trick.)
Third, you may need to know the exchange where the contract you want
is traded. Although a number of futures markets are traded on only one exchange, some are traded at several exchanges. For example, if you want to
trade hard red winter wheat, you have to specify the wheat contract traded
at the Kansas City Board of Trade, not the wheat contracts traded in Chicago
or Minneapolis.
Fourth, you may need to be specific about the time of day you want to
trade or the size of the contract you want to trade. Table 1.1 does not show
all the symbols differentiating between the day session’s regular trading
hours and the electronic or after-hours night sessions. Nor are the symbols
given for most of the mini-sized electronic products traded at the Chicago
Mercantile Exchange and the Chicago Board of Trade.

More than 70 percent of all futures markets now trade around the clock, including agricultural markets that once were traded only in the pits of an ex-

Electronic Era


change during a relatively short daily session. Orders can be placed electronically on most companies’ online trading platforms, although many firms
do not accept open orders and contingency orders for some markets. Chapter 10 explains the order process and contingency orders. It is also advisable
to check with your trading firm regularly regarding any changes in trading
hours and to see which orders are acceptable.
The electronic product that started it all for the futures industry came
from the Chicago Mercantile Exchange, as you might expect, when it developed Globex and launched trading in the e-mini S&P 500 and Nasdaq 100
index futures contracts. These contracts have been particularly attractive
to former investors in the stock market and are now among the most actively
traded futures contracts.
The Chicago Board of Trade launched a mini-sized contract based on the
Dow Jones Industrial Average in April 2002, and its popularity accelerated
in 2003, reaching a daily volume of more than 60,000 contracts a year later.
The contract has several key features that make it an attractive trading
• A 100 percent electronic market with 24-hour access.
• Lower margin than other stock index futures in dollars and as a percentage of contract value ($2,700 versus $3,563 for the e-mini S&P in the
middle of 2003).
• Simpler calculating and tracking components as the Dow only has 30
underlying stocks to monitor.
• For those with blue-chip stock portfolios, easier hedging by being able
to go short the Dow as easily as going long. Dow futures correlate closely
with the underlying Dow Jones Industrial Average.
• More spreading opportunities because the mini-sized Dow can be traded
against individual single stock futures, Diamonds or S&P 500, Nasdaq
100, or other index futures.
• Smaller minimum price fluctuations. Each point or tick in the mini-sized
Dow is $5. Each point in the e-mini S&P is $50, with the minimum tick
size a quarter of a point or $12.50. The two contracts trade in about a
10-to-1 relationship—a 10-point move in the e-mini S&P and a 100-point
move in the mini-sized Dow are each worth $500. A move of that size
would equate to an 18.52 percent gain for the mini-sized Dow versus a 14
percent gain for the e-mini S&P, using the margin amounts previously
Perhaps the biggest attraction of the mini-sized Dow is that it is based
on the best-known U.S. stock market barometer, which is more than a century old and recognized around the world. When you ask how the stock market did today, most people think of the Dow.



Next to the electronically traded stock index contracts, probably the most
exciting new futures market area is single stock futures (SSF). SSFs were
launched on two new U.S. exchanges on November 8, 2002, after a twodecade moratorium on that type of contract. They had been trading on foreign exchanges with moderate success for some time but had been banned
in the United States by an agreement that allowed trading to begin in stock
index futures in 1982. The realization that the United States might lose out
on market share to foreign competitors in a potential major new market
was high on the list of factors that prompted politicians and regulators at
the Securities and Exchange Commission and Commodity Futures Trading
Commission to finally resolve jurisdictional issues to allow trading in SSFs.
SSFs are an innovative product and could change the way the world invests on Wall Street in the future. Investors who have limited their investments to the stock market especially may benefit from this new market.
Imagine having the leverage to trade 100 shares of a popular stock for only
a 20 percent margin requirement and not having to pay a stock firm the broker loan rate to sell a stock short (if they can loan it to you at all). Assume,
for example, that Microsoft is priced at $25 per share. The futures contract
size is 100 shares so the contract value is $2,500. With an initial margin requirement of 20 percent of the value of the contract, you have to put up only
$500 to either buy or sell Microsoft futures instead of $1,250 it would take
to buy 100 shares of Microsoft shares at the minimum margin rate in the
stock market.
With SSFs you can open a futures trading account, buy a cash Treasury
bill, and trade a broad range of markets beyond SSFs while earning interest
instead of paying interest. The best part is being able to go long or short without prejudice and having access to the market by trading from your computer at home or work. These developments may not make broker-dealers
happy but are good news for individual traders.

These stock-related trading vehicles reinforce my optimism about the popularity of futures trading, not only in the United States but also around the
globe as people attempt to increase their wealth and raise their standard of
living. I believe the explosive growth in futures has come out of the dismal
losses many investors suffered during the great bear market in equities since
the peak in 2000.
Investors are now becoming more educated and open to other opportunities rather than limiting themselves to recommendations from their stock-

Bull Market for Futures


broker or investment advisor. The story earlier in this chapter about the
gentleman who never traded futures because his stockbroker said he would
lose his shirt is a testimonial to the fact that more and more investors—
most likely, people just like you—want to learn more.
Here is another example. I gave a seminar presentation in August 2002
to the Chicago chapter of the Cornerstone Investors Group, speaking to
about 70 people. I asked how many folks in the audience were trading futures. I believe about three people raised their hands, and I think two were
clients of mine.
The president of the group, Mark Anderson, invited me back in April
2003, reminding me that I said to his group in 2002, “If the balance of you
are not trading futures, then you will be sooner or later.” Just eight months
after that 2002 seminar, I asked the same question at the April seminar,
which had about 85 people. First, the investment club membership had
grown and, second, it seemed like almost everyone raised their hands. I was
What happened here? Well, this investor group had started to learn and
discovered the benefits of trading futures and how to apply technical analysis to the markets. They were taking control of their own financial destiny.
A whole lot of people are now interested in the futures markets and not
just from the town of Schaumburg, Illinois, or in Tampa Bay, Florida, where
the Cornerstone group was founded. The reach of traders wanting to learn
this form of derivative trading stretches to Ireland, England, Europe, Asia,
Australia—worldwide. I hope this book helps to keep you focused and financially prepared for the years ahead and helps you with the process of
continually learning the ebb and flow of the markets.


The Market Driver

Everyone needs constant education and training.
The more you keep yourself informed, the better
honed your instincts and decision-making
—Linda Conway

he term fundamental analysis refers to the study of tangible information about a market such as supply and demand statistics and expectations about what these numbers might be. Markets are a two-way
street: Supply and demand are key factors in determining price, and price
often is a factor in supply and demand.
Supply and demand comes from the perceived value that is placed on a
stock, commodity, or any derivative product. In its simplest definition, supply is the amount of a given stock, product, or commodity that is available
to the market, either in excess or limited at a given price depending on the
number of sellers. Price establishes a resistance level when the supply of a
particular product or stock is adequately provided.
Demand, the amount of buying or lack of buying, plays an integral role
in establishing how high or low prices can go and is generated by buyers.
Demand establishes a support level for prices.
Numerous events directly affect the outcome of both supply and demand, but some are more critical than others. For example, for agriculture
products from grains to livestock, weather is a crucial element in determining supply. In the event of a drought, grain production could be in short
supply and livestock could suffer weight loss or be forced to market in
large numbers if it appears scarce feed may become too expensive. In harsh




FUNDAMENTALS: The Market Driver

winters, grain movement could be slowed and livestock could perish, resulting in supply disruptions that could cause prices to go higher in a steady
or rising demand environment.

In the financial arena, when the Federal Reserve lowers short-term interest
rates, economic activity theoretically accelerates due to an increase in commerce as a direct result of the cost of doing business becoming less expensive. However, events do not always unfold as theory suggests.
The Federal Reserve began an aggressive campaign to lower interest
rates to kick start the U.S. economy in 2001. It cut short-term rates 13 times,
11 of those cuts amounting to 4.75 percentage points coming during 2001, a
difficult period for the U.S. economy. Then in November 2002 the Fed cut
rates another 50 basis points in what it called a “preventive” action against
possible economic weakness as the United States was preparing to attack
Iraq to combat global terrorism and oust Saddam Hussein and his weapons
of mass destruction. The invasion was a quick one—I think the UN Security
Council meeting debates took longer than the actual military operation.
However, U.S. economic growth still did not accelerate as expected, so
on May 6, 2003, the Fed slashed rates for the 13th time. That 25-point cut
dropped the Fed funds rate to 1 percent, and Federal Reserve Chairman Alan
Greenspan even mentioned combating potential deflation as a reason for
making this move!
The whole investment world did an about-face. Most people thought
the Fed was getting closer to actually raising interest rates rather than lowering them, and there was speculation that the Fed would take other unconventional means such as buying back 10-year and 30-year bonds to lower
rates for longer-term maturities. Mortgage rates fell to the lowest level in
nearly 50 years. The market’s focus shifted to watching the Producer Price
Index, the Consumer Price Index, and employment plus any other reports
that would hint at a stronger manufacturing sector as well as any that would
indicate a decrease in the jobless rate.
These were some unconventional responses to some unconventional
moves, but the key point is that it is important to grasp the significance of
the underlying economic fundamentals and the implications they might have
for any market you are trading.
Interest rates control the cost of money. Those who can foretell what
money will cost to lend or borrow have the upper hand in the investment
community. Rates dictate many other factors, especially because they are
one of the variables in calculations to determine fair-market values from
stock index futures to the broker loan rates for stock traders. It isn’t just

Reports, Reports


mortgage companies that have to guard against changes in interest rates,
but a broad range of businesses have to consider interest rate levels in their

One of the advantages of trading futures is that the government releases
dozens of reports every week, and the media provides additional material
that offers insights into what might lie ahead for market prices. Determining
the direction of the economy from reading economic reports is vital for understanding the potential for the direction of interest rates as well as gauging the health of the various sectors of the economy.
For example, government reports such as those on employment may
reveal what the potential for future household disposable income is and give
analysts and economists an idea of how much spending could occur based
on the number of Americans working. News articles give you the ability to
follow and understand the political scene, both on international and domestic levels. If Congress passes a bill to donate more wheat than expected, then
this action may have a more bullish impact on the price of wheat futures. Or
if Congress passes laws to change the tax rate on capital gains, you might be
able to speculate on what the stock market or other financial markets
may do.
If the European Central Bank announces a lower than expected interest
rate adjustment, it is likely to affect the value of the euro and, inversely, the
U.S. dollar. If values of these currencies shift abruptly and to a severe degree,
then, of course, products that are imported and exported would be priced
differently and, ultimately, could cause a ripple effect on costs and prices of
goods and services in the United States and overseas.
One reason you want to be educated and up-to-date on developments
in the economy is because they usually dictate how different financial products and futures prices will perform. The stock market likes to see healthy
economic growth because that usually equates to better or substantially
larger corporate profits. The bond market prefers a slower, more sustainable
growth rate that will not lead to inflationary pressures. By watching and
tracking economic data and getting insights from analysts and economists,
investors will be better able to keep in tune with the markets and their
In fact, you should be aware of what could happen before most reports
are released. That is why news services often give the schedule for current
events and special reports. Publications such as Barron’s, Investors Business Daily, or the Wall Street Journal will often give you a consensus of
analysts’ opinions on what to expect and show you what you need to know


FUNDAMENTALS: The Market Driver

to stay in tune with the markets. Most futures brokerage firms also provide
special calendars that include the dates and times that most major economic
and agricultural reports are released.
Trading is not an easy venture, and one helpful bit of advice I would
emphasize is that you should always be aware of the day’s current events
and scheduled reports if you are in the markets. Not knowing what day or
time a report is released could be hazardous to your financial health. Knowing about a major report before it is released is often useful because you
have a chance to eliminate a surprise from an adverse market move. Even
if you are not a fundamental trader, you should, at the very least, be aware
of the main fundamental factors that might affect the markets you are trading and the impact reports and events may have on the market.

Here are some of the economic terms, events, and reports that U.S. traders
should know and watch, including a brief explanation of why they are important to investors. If you did not pay attention in your economics classes,
this section will bring you up to speed.
Federal Open Market Committee (FOMC) Meetings and Policy
Announcements The FOMC consists of seven governors of the Federal
Reserve Board and five Federal Reserve Bank presidents. The FOMC meets
eight times a year—roughly every six weeks—to determine the near-term
direction of monetary policy. Whether there is a change in rates or not, the
FOMC announces its decision immediately after FOMC meetings.
A few accompanying statements the Fed may make after announcing
any adjustments in interest rates may have as much influence on markets
as a change or no change in rates themselves. For example, the FOMC may
take a “neutral” stance on the outlook for the economy. Or it may point to
prospects for growth or suggest the potential for economic weakness or inflationary pressures. The FOMC actions or comments can have a powerful
impact on markets.
Treasury Bonds, Bills, and Notes The U.S. government issues several different kinds of bonds through the Bureau of the Public Debt, an
agency of the U.S. Department of the Treasury. Treasury debt securities are
classified according to their maturities:
• Treasury bills have maturities of 1 year or less.
• Treasury notes have maturities of 2 to 10 years.
• Treasury bonds have maturities of more than 10 years.

What to Watch, What It Means


Treasury bonds, bills, and notes are all issued in face values of $1,000, though
there are different purchase minimums for each type of security.
Interest Rates, Financial Markets and Bonds U.S. Treasury
bonds, by virtually any definition, are simply a loan. The U.S. government
borrows the funds it needs to operate, including financing the federal
deficit. Ultimately, taxpayers will have to pay back the loan.
When a bond is issued, the price you pay is known as its face value.
Once you buy it, the government promises to pay you back on a specific day
known as the maturity date. It issues that instrument at a predetermined
rate of interest, called the coupon. For instance, if you buy a bond with a
$1,000 face value, a 6 percent coupon, and a 10-year maturity, you would
collect interest payments totaling $60 in each of those 10 years. When the
decade is up, you get back your $1,000.
If you buy a U.S. Treasury bond and hold it until maturity, you will know
exactly how much you’re going to get back. That’s why bonds are also known
as fixed-income investments—they guarantee you a continuous set income
backed by the U.S. government. What confuses most investors in bonds is
the concept of yield and price. Simply stated, when yield goes up, price goes
down, and vice versa.

Government Reports
Beige Book A combination of economic conditions from each of the 12
Federal Reserve regional districts, the Beige Book is aptly named because
of the color of its cover (really). This report is usually released two weeks
before the monetary policy meetings of the FOMC. The information on economic conditions is then used by the FOMC to set interest rate policy. If the
Beige Book portrays an overheating economy or inflationary pressures, the
Fed may be more inclined to raise interest rates to moderate the economic
pace. Conversely, if the Beige Book portrays economic difficulties or recession conditions, the Fed may see a need to lower interest rates to stimulate
Gross Domestic Product (GDP) GDP is the broadest measure of aggregate economic activity and accounts for almost every sector of the economy. Analysts use this figure to track the economy’s overall performance
because it usually indicates how strong or weak the economy is and helps
to predict the potential profit margin for companies. It also helps analysts
determine whether economic growth is accelerating or slowing down. The
stock market likes to see healthy economic growth because that translates
to higher corporate profits and higher share values.


FUNDAMENTALS: The Market Driver

International Trade and Current Account Figures These numbers measure the difference between imports and exports of both goods
and services. Changes in the level of imports and exports are an important
tool for gauging economic trends, both domestically and overseas. These
reports can have a profound effect on the value of the dollar. That value, in
turn, can help or hurt multinational corporations whose profits overseas
can diminish when they convert their funds back to the United States, especially if the U.S. dollar is overvalued. Another valuable aspect of such reports is that imports can help to indicate U.S. demand for foreign goods, and
exports may show demand for U.S. goods in overseas countries.
Index of Leading Economic Indicators (LEI) This report is a composite index of 10 economic indicators that typically lead overall economic
activity. The LEI index helps to predict the health of the economy and may
be an early clue about the prospects for recession or economic expansion.
Consumer Price Index (CPI) The CPI measures the average price level
of goods and services purchased by consumers and is the most widely followed indicator of inflation in the United States. Monthly changes represent
the inflation rate that is quoted widely and influences a number of markets.
Inflation is a general increase in the price of goods and services. The relationship between inflation and interest rates is the key to understanding
how data such as the CPI influence the markets. Higher energy prices, manufacturing cost increases, medical costs, imbalances in global supply and
demand of raw materials, and prices of food products all weigh on this report. For example, if gas prices at the pump escalate and the cost to fill up
your car rises from, say, $30 a week to $50 or even $60 a week, you will have
less spending money for other items. It may not affect you immediately, but
a longer duration of higher prices will hit your pocketbook.
Even weather can be a factor for short-term changes in food prices. What
would be the cost of tomatoes at the grocery store after a damaging freeze
in California or in Georgia? Maybe $3 or $4 per pound? Any grocery shopper
can probably recall when such price spikes occurred. The restaurants that
serve salads lose revenue as well as the farmer whose crop is destroyed.
These factors all play a part in the CPI number. The core rate is the inflation number that excludes the volatile food and energy components. Economists track these numbers; you should, too.
Producer Price Index (PPI) Formerly known as the Wholesale Price
Index, the PPI is a measure of the average prices for a fixed basket of capital and consumer goods paid by producers. The PPI measures price changes
in the manufacturing sector. The inflation rate may depend on a general increase in the prices of goods and services.

What to Watch, What It Means


Institute of Supply Management (ISM) Index Formerly known as
the National Association of Purchasing Managers (NAPM) survey, the ISM
report provides a composite diffusion index of national manufacturing conditions. Readings above 50 percent indicate an expanding factory sector,
readings below 50 percent, a contracting sector. The ISM Index helps economists and analysts get a detailed look at the manufacturing sector of the
economy, a major source of economic strength that can have a bearing on
the nation’s employment situation, a key to economic health.
Durable Goods Orders This report (Manufacturers’ Shipments, Inventories, and Orders) reflects new orders placed with domestic manufacturers for immediate and future delivery of factory-made products. Orders
for durable goods show how busy factories will be in the months to come as
manufacturers work to fill those orders. The data not only provide insight
into demand for things like washers, dryers, and cars but also take the temperature of the strength of the economy going forward.
Industrial Production and Capacity Utilization These rates measure the physical output of the nation’s factories, mines, and utilities and reflect the usage level of available resources. Because the manufacturing
sector accounts for an estimated one-quarter of the economy, these reports
can sometimes have a big impact on stock and financial market movement.
The capacity utilization rate provides an estimate of how much factory capacity is in use. If the utilization rate gets too high (above 85 percent), it can
lead to inflationary pressures.
Factory Orders The dollar level of new orders for manufacturing
durable and nondurable goods shows the potential for factories to increase
or decrease activity based on the amount of orders they receive. This report
provides insight into the demand for not only hard goods such as refrigerators and cars, but also nondurable items such as cigarettes and apparel.
Business Inventories Fed Chairman Alan Greenspan is said to be
among those who watch the report of business inventories, so you should
become familiar with it as well. This report shows the dollar amount of inventories held by manufacturers, wholesalers, and retailers. The level of inventories in relation to sales is an important indicator for the future direction
of factory production.
Consumer Confidence If there is one area that has been watched
most carefully in recent years, it is consumer sentiment. Several surveys or
polls gauge consumer attitudes. Among the best known are those conducted
by The Conference Board and the University of Michigan. These surveys


FUNDAMENTALS: The Market Driver

reveal what consumers think about present conditions as well as what their
expectations are for future economic conditions.
The level of consumer confidence is generally assumed to be directly related to the strength or weakness for consumer spending, which accounts for
two-thirds of the U.S. economy. Generally speaking, the more confident consumers are about their own personal finances, the more likely they are to
spend. If they have money in the bank and feel confident that their job is secure, buying an extra gadget or splurging on a night out usually won’t be any
trouble. In contrast, if times are tough, then the purse strings get pulled in.
These indications from one month to the next give analysts an idea of the
potential for shifts in future spending habits that can help or hurt developments in the economy from durable goods sales to home or car purchases.
Employment Situation The key to consumer confidence often depends
on the status of jobs. The monthly unemployment rate measures the number of unemployed as a percentage of the nation’s workforce. Non-farmpayroll employment tallies the number of paid employees working part-time
and or full-time in the nation’s business and government sectors.
Several important components are included in this report, one being the
average hourly workweek that reflects the number of hours worked in the
nonfarm sector. Another component is average hourly earnings, which
shows the hourly rate employees are receiving.
There are two portions of this report, one a weekly report released
every Thursday morning and the other the more influential monthly figures
that are usually released on the first Friday of every month.
Employment Cost Index (ECI) The ECI provides a measure of total
employee compensation costs, including wages and salaries as well as benefits. It is the broadest measure of labor costs and helps analysts determine
trends in the cost that employers have from paying employees. This measure can give economists a clue as to whether inflation is perking up from
a cost of business standpoint. If a company needs to pay more to hire qualified workers, then the cost of doing business increases and profit margins
are reduced. Companies usually have to raise their prices to consumers as
their costs increase. That is when the inflation theme starts to play out.
Productivity and Costs Productivity measures the growth of labor
efficiency in producing the economy’s goods and services. Unit labor costs
reflect the labor costs of producing each unit of output. Both are followed
as indicators of future inflationary trends. Productivity growth is critical because it allows for higher wages and faster economic growth without inflationary consequences.


FUNDAMENTALS: The Market Driver

mentioned, this narrow piece of data has a powerful multiplier effect
throughout the economy and, therefore, across markets where you may have
your investments.
Existing Home Sales Existing home sales (the number of previously
constructed homes with a closed sale during the month, also known as home
resales) are a larger share of the market than new home sales and provide
another indication of housing market trends. This statistic also provides
clues to the demand for housing and for economic momentum based on the
ripple effect.
Mortgage Bankers Association Purchase Applications Index This
weekly index of purchase applications at mortgage lenders is a good leading
indicator for single family home sales and housing construction and is another gauge of housing demand and the resulting economic momentum.
Construction Spending This report goes beyond housing to show analysts the amount of new construction activity on residential and nonresidential building jobs. Commodities such as lumber are sensitive to housing
industry trends. In addition, business owners usually will put money into the
construction of a new facility or factory if they feel confident that business
is good enough to validate an expansion.
Consumer Credit One of the American consumers’ pastimes is to say
“Charge it” to purchase goods and services on their credit cards. Overall
changes in consumer credit can indicate the condition of individual consumer finances. On the one hand, economic activity is stimulated when consumers borrow within their means to buy cars and other major purchases. On
the other hand, if consumers pile up too much debt relative to their income
levels, they may have to stop spending on new goods and services just to pay
off old debts. That stoppage could put a big dent in future economic growth.
The demand for credit can also have a direct effect on interest rates. If
the demand to borrow money exceeds the supply of willing lenders, interest rates rise. If credit demand falls and many willing lenders are fighting
for customers, they may offer lower interest rates to attract business.

Other Reports and Information
The government isn’t the only source of information vital to the markets, of
course. Private research reports, company reports, and even anecdotal evidence gleaned from the news or from your neighborhood may provide
clues about the future of the economy and market prices.

What to Watch, What It Means


For example, you may be able to take the temperature of the economy
by watching travel reports. Are people going on vacations? Are they taking
two weeks or just three days? Staying close to home or going to exotic
places? Listening to your friends talking about their vacations and watching
airline traffic statistics may give you clues about travel that may be a good
guide for what’s happening to the economy that, in turn, may have a bearing
on what you are trading. In good times people tend to spend bigger money
on a vacation, where the number one activity is shopping, according to
Travel magazine. Lots of consumer spending says a lot about the vibrancy
of the economy and supports higher stock market prices. If you trade energy,
more travel means airline fuel consumption goes up, and that may trigger
an increase in energy prices.
Statistics and reports from a number of private sources can back up or
refute your observations. Reports from weather services may keep you
ahead of the crowd on crop developments or prospects for heating oil. The
National Oilseed Processors Association releases reports about the soybean
“crush” that can help you analyze the outlook for not only soybeans but the
feed component for livestock markets as well. The American Petroleum Institute releases weekly statistics on energy production and stocks. There
are many other similar sources of information, not to mention the dozens of
specialty newsletters providing information, insights, and advice on every
Then, of course, there are the earnings reports and other information
released by thousands of public companies that drive the prices of individual stocks. Because there are many more equity traders in the investment
world than there are futures traders, you may be more familiar with these
reports. If the equity markets generate normal or even subnormal returns
based on a historical standard as some forecast for the next few years, then
the appetite for making money may attract individual investors to move
into futures products because of the leverage available in futures and options. And many futures traders will have to become more familiar with what
affects the prices of stocks as new demands and needs for products that
combine features of stocks and futures are introduced.
Futures and options activity will continue to expand and change as
both types of traders come to markets such as the popular e-mini S&P 500
index futures, which went from a daily volume of around 300,000 contracts
in February 2002 to as many as 1,000,000 contracts a day within a matter of
months. Those numbers offer proof that stock investors are flooding into the
futures markets. The debut of single stock futures in November 2002 gave
individual investors the unique opportunity to trade individual stocks with
the features and benefits of the futures markets and will send futures volume
in stocks-related markets even higher.


FUNDAMENTALS: The Market Driver

More participation from a wider variety of players may create more
volatility, making it more important than ever to know what to look for in
reports and how they may affect price behavior. When looking at company
numbers, it is vital to decipher what the actual financial strength of the
company is and to listen to what guidance is being given for that company’s
future. If a company president or CEO states that earnings were good based
on spending cuts rather than revenue growth and, in addition, indicates that
future sales may be slow, then that information would not bode well for that
stock’s price. Further, it might suggest that all companies in that sector might
be susceptible to a slow period or economic contraction.
Therefore, it is relevant to discuss earnings and other aspects of analyzing stock prices such as supply and demand and their perceived valuations
in addition to general economic numbers. The common and most popular
gauge of stock value is the price/earnings ratio (P/E). The calculation is simple: Just divide the stock price by the earnings. A stock priced at $60 and
earning $6 per share has a P/E ratio of 10. There are several other means of
analyzing a stock’s value: changes in sales figures, announced increases in
dividend payouts, amount of debt, new contracts that will generate more
revenue, takeover situations, stock buy-back plans, and so on.
The leader or largest capitalized company in a sector or industry group
may set the tone for that sector and help drive prices in either direction. So
it is important for stock index futures traders to follow the developments of
key stocks or sectors. Listening to the earnings reports or conference calls
may give you facts rather than brokers’ opinions on what was said and provides another form of fundamental analysis.

I have just described only a few of the more popular economic reports and
indicators released every day. As you can see, there is definitely enough information released to create fuel for the fire that causes volatility in the
markets, emphasizing the importance of staying on top of the daily calendar
of events, especially when you have positions that may be affected by these
reports. Awareness of what is going on around you can help you become a
successful trader.
Market participants change, money flow changes, the world political
scene changes, the market’s focus changes. The reports mentioned and
their significance will probably evolve over time just as they have in the past.
For example, the old NAPM survey is now the ISM Index. And you may remember when money supply M-1 and M-2 figures were a big deal (1984) that
everyone in the market had to follow.

Staying with the Information Flow


The times do change, and entrepreneurs and swift students of the markets will rise to the occasion to understand what information will help give
them an edge in an effort to beat the street. This business attracts the savviest and smartest people in the world. Some are extremely well schooled, and
others are naturally gifted with good market sense and, well, sometimes with
just plain luck. You need to be aware that those people are the ones you are
up against as a market participant. If this is going to be your business, at least
knowing what the other team players follow may help you in your own
Of course, even the biggest and smartest players lose sometimes. The
markets do not discriminate. They like to take money away from the large
commodity trading advisor who has an Ivy League degree and a Phi Beta
Kappa plaque on the office wall as well as from the small speculator. As markets change and fundamental shifts in business cycles occur, you need to adjust so you can grasp where the market’s focus is and find the reports and
information that will keep you in tune with the fundamentals of the market.

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