If you are new to futures trading, it can all seem overwhelming. Which fundamental reports should you follow? Which technical analysis techniques will give you an edge? Which markets are the best to trade? There are far too many questions than I can possibly address in this brief article, but I will attempt to scratch the surface of the core concepts I think all new traders should know before they start trading. There are volumes of books and articles written on each of these tips, and I encourage you to explore these concepts further.
Fundamentals
Many traders who use technical analysis to make their trading decisions feel that fundamentals aren’t important, but I think savvy traders should be aware of the fundamental factors that are moving the market they are trading. This is basic supply and demand, economics 101. For example, if you are trading grains, you should be aware of how much is being planted, the yields, the weather, etc. If you are trading financial futures markets like the S&P 500 or Treasuries, you’ll want to be aware of what’s going on in the economy, and with interest rates.
It’s certainly not necessary to be an expert on the nuances of all the data, as it can be overwhelming. But it you are putting your money on the line, I think it’s important to be aware of the dynamics affecting the market you are trading. Who is buying this commodity? Who is selling? Why?
Most of the fundamental data that affects the ups and downs of the market is freely available to the public, released through financial media outlets and/or posted on governmental Web sites. It’s not important to have any advanced knowledge or even an opinion about the fundamentals, but it is important to know what the big professional traders and institutions are anticipating, and how they are positing themselves in the market based on those expectations.
For example, the Energy Information Administration (EIA) releases data weekly on crude oil and natural gas inventories. Analysts and economists who make their living studying the fundamentals of the market in detail will try to predict where they believe inventories stand each week before the data is released.
I provide my clients a calendar summarizing the key economic reports coming out each week for the various markets, along with these consensus forecasts among analysts. When you have an idea of what other market participants are expecting, it can help you plan your trading strategy. For example, analysts were expecting the February 2010 employment report to show a drop in non-farm payrolls of 68,000, and the unemployment rate to rise to 9.8 percent. When the Bureau of Labor Statistics released the report on March 5, non-farm payrolls only fell 36,000, and the unemployment rate came in at 9.7 percent. Those reports were better than most participants had expected, so the stock market rallied.
A related tip to this is that sometimes, market behavior isn’t logical. So you have to dig a little deeper. In the case of crude oil, heading into the March 3 weekly EIA report, analysts were expecting a surplus of more than 1 million barrels. When the data came out, the surplus was almost three times that amount. That should be very bearish for the market, right? The fundamental data showed we have more supply than demand, right? That day, crude oil closed higher, however, so what happened? This type of action is why we use the phrase “past performance is not always indicative of future results.” Sometimes, there are other factors at work in the markets to create short-term fluctuations you might not anticipate. You then might need to explore what those are. Over time under normal market conditions, the fundamentals will win out. So know what the market is looking for, and what it got, you’ll better understand why prices move.
Technical Analysis
Technical analysis is a complex topic that can encompass years of study. But even new traders can, and should, learn some basic concepts. One of these is identifying the trend. You can clearly see the downtrend in the chart of the British pound below in 2010. Fundamentals and technicals should be working together; when they are not (in the case of crude oil) that means you have to do some further investigation.
You should also be aware of market momentum, and two simple indicators you will find on most trading platforms are the Relative Strength Index (RSI) and Stochastics. They offer clues as to whether the trend may be exhausting itself; whether the market might be getting a little too bullish or bearish based on the fundamentals. This is reflected in the RSI readings. A reading below 30 is thought to be a flashing warning light that the market could be getting oversold and ready to turn up, while a reading above 70 is a warning that the market may be getting overbought and could turn lower. In the chart below, you can see how the RSI dipped below 30 in the British pound, and the market rebounded a bit off its lows.
It’s also important to know simple support and resistance. These are key price levels that act as a floor or ceiling on prices. Many technicians target similar support and resistance points to place their buy or sell orders, so just being aware of that fact is important. I record a daily technical analysis podcast for traders with what I see unfolding on the charts, available at www.letstalkfutures.com, along with key support and resistance points for traders to watch for in popular markets.
Volume and Open Interest
This is really part of technical analysis, and it’s something many traders don’t pay much attention to—but should. Volume can provide you valuable hints about the strength of the trend. Increasing volume means more people are excited about the market, while less volume means enthusiasm may be waning. If volume increases while the market is rising or falling, that indicates a healthy bull or bear market. When volume is decreasing as the market is rising or falling, that can tell you the trend may be weakening. You can’t have a bull market without feeding the bull (or a bear market without feeding the bear). That’s volume.
For example, The S&P 500 has been in an uptrend for a few weeks, but the volume has been weak. That’s a flashing yellow warning to proceed with caution if you looking to buy this market.
A related concept is open interest, which represents the outstanding positions in the market. That is, traders with pending positions that haven’t been closed out. In a healthy bullish trend, you want to see new buying interest, or new positions being established on a move. When volume increases, and open interest increases, you are feeding the bull. If the market goes up and open interest drops, it probably means the market is being driven by traders with short positions who are closing them out. There are now fewer positions in the market.
Catching the Breakout
Traders live for catching a big market breakout—a huge move with a huge return. But in my opinion, it’s nearly impossible to catch them, and you won’t likely have a breakout unless the fundamentals and technicals match up. Catching big breakouts are few and far between for most traders, so don’t base your success on it. Success comes for most by catching small moves within the trend, and by controlling your risk, which is my next tip.
Risk Management
You’ll go broke if you don’t have a plan to control your risk. If you are trading with leverage, you need to know when to get in, and when to get out. Know how much you are willing to risk on trade, know your exposure. Calculate your potential profit and loss before you enter a trade. Know how much you can risk and still stay in the game—and know when exactly you should get out so you can. Know which markets are appropriate for you to trade based on your account size, and your approach. There are many techniques to control your risk, which are beyond the scope of this article here. I’d be happy to discuss them further with you. That leads to our next tip, probability.
Risk, Reward and Probability
Not only should you have proper risk management techniques, you should be aware of the probable outcomes. You can’t expect every trade to be a winner. However, you can be successful even if every trade isn’t, as long as your winners are larger than your losers. You’ve probably heard the saying “cut your losses and let your profits ride,” which is the core of this concept. When you are wrong, get out and move on to another opportunity. Don’t let it turn into a big loser and wipe you out.
For example, if I am bullish corn and think the futures will move 10 cents, that would net me $500 profit, since each 1-cent move = $50. If I’m wrong, I’ll risk a move 5 cents lower (or $250), and then I’ll get out of the trade and move on. That’s 1 x 2. If I’m right, my profit will be twice what I’ll lose if I’m wrong. It’s like life insurance. You should determine which trades are higher-risk, and know that you’ll pay a higher price as result. Futures and options have unique risk profiles.
You can learn more about money management, calculating probabilities and using support and resistance in my article “Money Management Techniques of Traders.”
Options
A lot of people like using futures because of the ability to use leverage. However, you might not realize options can offer even greater leverage. Buying options can also offer you the ability to define your risk, which you can’t always do in futures. There are a wide variety of options strategies you can for greater control over your risk-reward probabilities. Many new traders don’t even consider options, but I encourage you to investigate the use of options to give you even more flexibility in your trading. The Lind-Waldock Web site has more information about options. I’d be happy to address any questions you might have, as well as how you might apply these concepts to a specific trading strategy.
Jeff Friedman is a Senior Market Strategist with Lind Plus. He can be reached at 866-231-7811 or via email at jfriedman@lind-waldock.com. You can follow Jeff on Twitter at www.twitter.com/LWJFriedman. Join Jeff for his monthly webinar, Friedman’s Futures Forecast, by visiting Lind-Waldock’s events page.
Futures trading involves substantial risk of loss and is not suitable for all investors.
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.
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