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Contents
1 2 3 G TECHNICAL ANALYSIS 101 THE IMPORTANCE OF METHOD TRADING TECHNICAL VERSUS FUNDAMENTAL ANALYSIS TIPS AND RESOURCES FOR ELECTRONIC TRADERS TYPES OF STOP ORDERS: A TUTORIAL 4 7 9 10 13

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MOVING AVERAGES EXPLAINED PIVOT-POINT TECHNIQUES THE VALUE OF FAIR VALUE BUILDING YOUR CME E-MINI® FUTURES TRADING STRATEGY THE BRILLIANCE OF GANN IN TODAY’S MARKETS WHEN TRENDS AREN’T YOUR FRIEND: HOW TO APPROACH DRAWDOWNS THE COMMITMENTS OF TRADERS REPORT: A CLUE TO WHO’S MOVING MARKETS

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INTRODUCTION TO FUTURES SPREADS TRADE BY THE BOOK: A GUIDE TO READING ORDER FLOW TECHNICAL ANALYSIS AND OPTIONS STRATEGIES FOR LONG-TERM POSITION TRADERS UNDERSTANDING OPTIONS SPREADS A MOVING AVERAGE THAT CAN MOTIVATE YOUR TRADING: TILLSON’S T3

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GLOSSARY OF TECHNICAL ANALYSIS TERMS GLOSSARY OF TRADING STRATEGIES TERMS GLOSSARY OF BASIC FUTURES TERMINOLOGY

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The Lind-Waldock Futures Technical Trading Guide

Professional traders know it takes an edge to successfully navigate the markets—and for many, technical analysis provides that edge. Technical analysis can be defined as an approach to forecasting commodity prices that examines the patterns of price change, rates of change, and change in volume of trading and open interest, without regard to underlying fundamental market factors. Whether it’s moving averages, pivot points, or Gann theory, the study of technical analysis can provide valuable insight into price action for virtually any market. This Guide contains a collection of informative articles that can help you learn more. The contents are organized by level; if you’ve never explored technical analysis or futures in general, the articles in Level One are the place to start. This section also offers a refresher on concepts you may be a bit rusty on. Level Two articles expand on the basics and offer some additional factors you might consider. Level Three articles are a bit more advanced, containing more sophisticated concepts and strategies for those already familiar with technical analysis and those who have already been trading futures.

While technical analysis methods may be the same for all traders, your own interpretation and analysis can offer you an edge that’s uniquely yours. For that reason, technical analysis has been called an art as much as a science. The authors of the articles in this Guide are simply offering their interpretation of the concepts. Advice is to be taken as educational in nature only, and not to be construed as specific trading advice. Articles from outside authors unaffiliated with Lind-Waldock have been reprinted with permission. Lind-Waldock is not responsible for any advice or content from such outside authors reproduced herein, nor from their respective Web sites.

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 service 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. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder. ©Copyright 2007 Lind-Waldock, a division of Man Financial Inc. All Rights Reserved.

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Technical Analysis 101
BY JEFFREY FRIEDMAN

The world of technical analysis is huge and can be applied to virtually any market. There are literally hundreds of different patterns and indicators that traders claim to have success with.
There are two major types of analysis typically used to predict the performance of commodity futures—fundamental and technical. Fundamental analysis examines the supply and demand factors that influence price, while technical analysis is the study of price and price behavior. The world of technical analysis is huge and can be applied to virtually any market. There are literally hundreds of different patterns and indicators that traders claim to have success with. In this article, I’ll introduce you to a few very basic types of price charts and technical analysis tools.
WHAT IS TECHNICAL ANALYSIS? TWO BASIC CHART TYPES

Technical analysis is a method of evaluating commodities by analyzing statistics generated by market activity, past prices, indicators and volume. Technical analysts do not attempt to measure a commodity’s intrinsic value; instead they look for patterns and indicators on the charts that will determine a future performance.

Bar charts are some of the most popular charts used in technical analysis. They display the open, close, high and low for a specified time period. Bar charts can be used for any time frame.

Using charts as a primary tool, commodity traders who employ technical analysis look for peaks, bottoms, trends, patterns and other factors that affect price movement, which they then use to make buy or sell decisions. Technical analysis today includes such principles as the trending nature of prices, prices discounting all known information, moving averages, volume mirroring changes in price, and the identification of support and resistance levels. The price of a commodity represents a consensus between buyers and sellers of all the information about that commodity at any given point in time. It is the price at which one person agrees to buy and another agrees to sell. The price at which a trader is willing to buy or sell depends primarily on expectations.

The daily chart, which is the most popular time period, is often used to study price trends for the most recent six months. For longer-range trend analysis going back five or 10 years, weekly and monthly charts are more useful. Intraday charts can be used by day traders to plot prices for periods as brief as one minute. Each time period is a vertical line, with the top of the vertical line indicating the highest price the commodity traded at during the time period, and the bottom representing the lowest price. (See Chart 1) The closing price is displayed on the right side of the bar and the opening price is shown on the left side of the bar. A single bar represents one time period of trading. Candlestick charts, which have been around for hundreds of

Technical analysis reflects on historical prices in an effort to deermine probable future prices. This is done by comparing current price action (i.e., current expectations) with comparable historical price action in order to predict a reasonable outcome. The technician might observe that history repeats itself in price behavior because human behavior repeats itself.

years, are similar to bar charts in that they also display the open, close, high and low. The primary difference is that if the closing price is above the opening price, the body is usually clear, white or green. If the closing price is below the opening price, the body is usually solid, black or red. (See Chart 2)

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Chart 1: Bar Chart

Chart 2: Candlestick Chart

TECHNICAL INDICATORS YOU CAN USE

contract finishes up with the number of days it finishes down. This indicator is a big tool in momentum trading. The RSI ranges from 0 to 100. A market is considered overbought around the 70 level and you should consider selling. This number is not written in stone. In a bull market, some believe 80 is a better level to indicate an overbought price, since prices often trade at higher valuations during bull markets. Likewise, if the RSI approaches 30, price is considered oversold, and you should consider buying. Again, make the adjustment to 20 in a bear market. The shorter the number of days used, the more volatile the RSI is and the more often it will hit extremes. A longer-term RSI is more rolling, fluctuating a lot less. Different commodities and futures contracts have varying threshold levels when it comes to the RSI. Prices in some futures contracts will go as high as 7580 before dropping back, and others have a tough time breaking past 70.
USING SUPPORT AND RESISTANCE

A moving average is one of the easiest indicators to understand. For example, to calculate the 50-day moving average, you would add up the closing prices from the past 50 days and divide them by 50. Because prices are constantly changing, the moving average will move as well. Moving averages are most often compared or used in conjunction with other indicators such as Moving Average Convergence Divergence (MACD) or the Relative Strength Index (RSI) discussed below. While you can choose any time period you wish, the most commonly used moving averages are of 10, 20, 40, and 50 days. Each moving average provides a different interpretation of what the commodity price will do. There is no one right time frame to use. The longer the time spans, the less sensitive the moving average will be to daily price changes. Moving averages are used to emphasize the direction of a trend and smooth out price and volume fluctuations (or “noise”) that can confuse interpretation. Typically, when the price moves below its moving average it is a bad sign because the commodity is moving on a negative trend. The Moving Average Convergence Divergence is one of the simplest and most reliable indicators available. MACD uses moving averages, which are lagging indicators, to include some trendfollowing characteristics. These lagging indicators are turned into a momentum oscillator (a measure of how much prices have changed over a given time period) by subtracting the longer moving average from the shorter moving average. The resulting plot forms a line that oscillates above and below zero, without any upper or lower limits. MACD is a centered oscillator, which fluctuates above or below a center point, and the guidelines for using centered oscillators apply. When we talk about the strength of a commodity futures contract, there are a few different interpretations, one of which is the Relative Strength Index. The RSI compares the number of days that the

Support and resistance are price levels at which movement should stop and reverse direction. Think of support and resistance as levels that act as a floor or a ceiling to future price movements. Support is a price level below the current market price, where buying interest should be able to overcome selling pressure—and thus keep the price from going any lower. Resistance is a price level above the current market price, where selling pressure should be strong enough to overcome buying pressure—and thus keep the price from going any higher. (See Chart 3) One of two things can happen when a futures contract price approaches a support or resistance level. It can act as a reversal point, or in other words, when the futures price drops to a support level, it will go back up. Or, support and resistance levels can reverse roles once they are penetrated. For example, when the market price falls below a support level, that former support level then becomes a resistance level when the market later trades back up to that level.

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Chart 3: Resistance and Support

POPULAR CHARTING PATTERNS

Head and Shoulders. This chart formation resembles an “M” in

Many of us believe that history repeats itself. Using successful and proven price patterns from price charts is a method technical analysts widely use. There are entire volumes of textbooks written on technical analysis. It’s one of those fields where everyone has a different theory on what works and what doesn’t. I suggest you do some homework and back test your desired strategy. Back testing means looking back at several years’ worth of charts to see how a particular futures contract reacts. Different markets do different things. Here are just a few examples:
Cup and Handle. This is a pattern on a bar chart that can be as

which a price rises to a peak and then declines, then rises above the former peak and again declines, and then rises again, but not to the second peak and again declines. The first and third peaks are shoulders, and the second peak forms the head. This pattern is considered a very bearish indicator.
Double Bottom. A double bottom occurs when a price drops to

a similar price level twice within a few weeks or months producing a pattern that resembles a “W.” You should buy when the price passes the highest point in the handle. In a perfect double bottom, the second decline should normally go slightly lower than the first decline to create a shakeout of jittery traders. The middle point of the “W” should not go into new high ground. This can be a very bullish indicator.
Jeffrey 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 for more information about this topic or others.

short as seven days or as long as 65 days. The cup is in the shape of a U. The handle has a slight downward drift. The right hand side of the pattern has low trading volume. As the price comes up to test the old highs, the price will incur selling pressure by the people who bought at or near the old high. This selling pressure will make the price trade sideways with a tendency towards a downtrend for four to 30 days, and then it may take off. It looks like a pot with handle.

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The Importance of Method Trading
BY LIND-WALDOCK

It’s very important that you develop a method of trading that matches your trading goals and personality, so you can protect yourself from your own weaknesses. Without a method, you run the risk of succumbing to the temptations and stresses that are constantly present in the market.
In futures speculation, there are winners and losers. Some speculators put themselves in positions (either because of their emotional makeup or because of a lack of knowledge) from which they cannot hope to emerge successfully. While their motivations may be primarily psychological, part of their failure can be attributed to a lack of knowledge of trading techniques. There are many successful trading methods or plans. But, what works for you won’t necessarily work for someone else. It’s very important that you develop a method of trading that matches your trading goals and personality, so you can protect yourself from your own weaknesses. Without a method, you run the risk of succumbing to the temptations and stresses that are constantly present in the market. Here are several practical rules that can be applied to any trading system. These are rules we believe should be integrated into your trading system, so that you have your best chance of success.
1. ADOPT A DEFINITE TRADING PLAN. 3. YOU SHOULD BE ABLE TO BE RIGHT 40 PERCENT OF THE TIME AND STILL SHOW A PROFIT.

In speculating, it is unrealistic to expect to be right every time. If you follow proper trading techniques, you should be able to cut losses short and let profits run so that even being right less than half the time will yield profits.
4. CUT YOUR LOSSES AND LET YOUR PROFITS RIDE.

One basic failing of speculators is that they put a limit on profits and no limit on losses. They hate to admit being wrong, and will often let losses ride in hopes that the market will turn around. After a while, they begin hoping for a small loss and give up hoping for a profit. There is an old saying, “you never go broke taking a small profit”...but you’ll certainly never get rich that way. Small profits are the direct opposite of the best way of making money in speculation. If you are correct when entering a speculative situation, you will know it almost immediately and will show a profit. However, if you are wrong, you will show a loss and you should remove yourself from the situation as quickly as possible. Taking a small loss does not necessarily mean your thinking was wrong. It simply means that your timing was perhaps incorrect and that you should wait for the correct timing and situation to allow you to reenter the market. Remember, in any speculative situation, the market is the final judge. You must let the market tell you when you are wrong and when you are right. If you show a profit, ride it until the market turns around and tells you that you are no longer right. Then get out, but not before! On the other hand, the market will also tell you if you are wrong, and it is a serious mistake to argue with the market.

Because of the emotional stress inherent in any speculative situation, you must have a predetermined method of operation that includes a set of rules by which you operate and to which you rigidly adhere, in order to protect you from yourself. Very often your emotions will tell you to do something totally foreign or negative to your market-trading plan. If you’re following a plan, there’s a better chance you’ll avoid knee-jerk decisions.
2. IF YOU’RE NOT SURE, DON’T TRADE.

If you’re in a trade and feel unsure of yourself, take your loss or protect your profits with a stop. If you are unsure of a position, you risk being influenced by any number of extraneous and unimportant details.

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5. IF YOU CANNOT AFFORD TO LOSE, YOU CANNOT AFFORD TO WIN.

11. YOU CAN ALWAYS SELL THE FIRST RALLY OR BUY THE FIRST BREAK.

Losing is a natural part of trading. If you are not in a position to accept losses, either psychologically or financially, you have no business trading. In addition, trading should be done only with surplus funds that are not vital to daily expenses.
6. DON’T TRADE TOO MANY MARKETS.

Generally, a market that has just established a trend (either up or down) will have a reaction. Good interim profits can be made by recognizing this reaction and taking advantage of it. For example, in a bull market, the first reaction will generally be met by investors waiting to buy the break. This support generally causes the market to rally. The reverse is true of a bear market.
12. NEVER, EVER STRADDLE A LOSS.

It’s difficult enough to successfully trade and understand a specific market. It’s next to impossible for an individual, especially a beginner, to be successful in several markets at the same time. The fundamental, technical and psychological information necessary to trade successfully in more than a few markets is more than you probably have the time or ability to manage. All of these rules are part of a common sense approach to making
7. DON’T TRADE IN A MARKET THAT IS TOO THIN.

A loss by itself is difficult enough to accept; however, to lock in this loss, making it necessary for you to be right twice rather than once, which you previously found impossible, is sheer absurdity.

trading decisions that will help you manage your performance. In fact, you’ll find that if you don’t follow a trading method, you’ll never know what to credit your results to. If you follow a set of rules, you’ll be able to diagnose your setbacks and successes, evaluate the quality of your rules and determine whether you have actually been following them with discipline. Whatever method you apply, just be sure it fits your comfort levels for style, performance and risk tolerance.

A lack of public participation in a market will make it difficult, if not impossible, to liquidate a position at anywhere near the price you want.
8. BE AWARE OF THE TREND.

It is vitally important that you are aware of a strong force in the market, either bullish or bearish. When this force is at its height it would be folly to attempt to buck it; however, you must learn to recognize when a trend is about to run its course, or is near exhaustion. This will help you protect yourself from staying in the market too long, and you’ll be able to change direction when the trend changes.
9. DON’T ATTEMPT TO BUY THE BOTTOM OR SELL THE TOP.

It simply can’t be done unless you have the aid of a crystal ball. Be content to wait for the trend to develop and then take advantage of it once it has been established.
10. NEVER ANSWER A MARGIN CALL.

This rule serves as a stop loss when your position has weakened considerably. If you follow this rule, you will be forced to get out of the market before total disaster sets in. It is often difficult to admit you’re wrong and get out of the market (which you probably should have done well before you received a margin call). However, the presence of a margin call should act as a clear and final warning that you have let your position go as far as you conceivably can (unless the initial margin is out of line with the volatility of the contract).

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Technical Versus Fundamental Analysis
BY STUART KAUFMAN

The debate between fundamental and technical analysis has raged for decades. It is important to clarify the difference.
I am often asked what are the differences between fundamental and technical analysis, and how do I decide which to use when I trade.
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Fundamental Considerations

Technical Considerations
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Economic factors Supply and demand Market-specific data

Price action Chart patterns Volume and open interest

The debate between fundamental and technical analysis has raged for decades. It is important to clarify the difference. By definition, fundamentals consist of the economic factors behind a commodity, namely the influences on supply and demand. For example, fundamentals of cotton would include the size of last year’s crop, the amount of cotton left from that harvest that is still available for export and domestic use, the pace of exports this year, the progress of the upcoming crop, and projected weather that could affect its growth. These are all fundamentals, and if it looks like a lot of information, it is. Assuming that one is able to monitor all these factors, the next task is to form a “big picture” of the market and then try to determine how these factors could affect price over the next three to six months. Doing this is a key task in selecting markets that provide the greatest opportunities for profit. Technical analysis, on the other hand, is the study of charts, chart formations, and an array of technical indicators that affect volume, price momentum, strength of buying or selling, and so on. Because technical trading tends to be more concrete and tangible (e.g., buy when prices hit this line), it attracts both the mathematical and the statistical-oriented crowds. Pure technicians believe all the current fundamentals are always priced into a futures contract at any given time. Therefore, there is no use in studying the fundamentals because they are all reflected in the price patterns.

I think that may be true to a certain extent. Most of the known fundamentals could be reflected in the current price, because fundamental knowledge often lags technical indications of a price move. What the pure technicians overlook is that studying fundamentals is not done to determine how they are impacting the price today, but rather to project how these factors could impact prices in the future. My opinion is that it’s important to be cognizant of both kinds of analysis, but that technical analysis tends to get you in the market quicker and at better price levels.
Stuart Kaufman is a Senior Market Strategist at Lind Plus. If you would like more information about this topic or others, you can contact him at 800-924-1060 or via email at skaufman@lind-waldock.com.

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Tips and Resources for Electronic Traders
BY DAVE HOWE

What you need and where you will get it depends to a great extent on the type of trader you want to be, the trading style you believe will be most suited to your personality, and the amount of money and time you have to devote to trading.
Whether you are learning to trade online for the first time or are looking to improve your current online trading skills, finding the right resources and the right support can be critical to your success. As the old saying goes, “no man is an island.” As a self-directed trader making your own decisions, you may at times feel like you are on an island all alone. But there are plenty of resources to help you gain confidence. What you need and where you will get it depends to a great extent on the type of trader you want to be, the trading style you believe will be most suited to your personality, and the amount of money and time you have to devote to trading. The type of trader you choose to be will have some bearing on the resources you need—whether you plan to trade via technical or fundamental factors, what markets you plan to trade, and whether you plan to day-trade or hold longer-term positions. Years ago all you might have needed to trade was a phone and an idea, but in today’s technological era, a personal computer and an Internet connection to link you to the marketplace are essential—along with telephone service as a backup.
TRADING PLATFORM

If there is some disruption in your online connection, you need access to a means of live technical support to assist you with any questions.
Ease of Use. The platform should be simple to understand and

operate to facilitate transmission of orders quickly. If you are an active trader or plan to be, you want to see market depth, which is the listing of a market’s most recent bids and offers. Check to see if you can place an order from the market-depth screen. Customization is another important feature. What data do you want to see when you’re trading? If you are looking at a chart or price quote, a platform may formulate the order for you so all you have to do is click “buy” or “sell.” Procedures to enter an order should be clear and easy, yet should have enough safeguards to reduce your chances of making mistakes as you make your trades.
Market Access. You will likely want a trading platform that has

the most flexibility to trade a wide variety of markets. At a later date, you may want to add a new market you aren’t interested in trading right now, so look at the big picture. Find out which global exchanges your firm is connected to. New, attractive contracts are being established all the time all over the world. If you see a trading opportunity on an overseas exchange, your broker should be able to facilitate trading in those markets.
Type of Platform. Do you want a downloadable version that high-

Selecting a trading platform is an important first step as you learn to trade online because you may want to not only enter your orders, but also do your own analysis. There are several aspects of a platform to consider.

lights speed and accuracy? Do you want a browser-based platform? What about wireless trading? The Internet can be a rather fragile network and may not always be the most reliable means of conveying your orders, especially during critical periods when timing is most important.

Simulated Trading. One of the most useful training tools to learn

to trade online, get comfortable with a trading platform, or to test a trading system is simulated trading. Everything about the trading is real except that you use “virtual” money instead of real money. Although it cannot match the emotional involvement real trading does, simulated trading helps you learn the mechanics of trading

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and become familiar with the trading platform before you have to deal with the pressure of trading real money. Depending on your knowledge of trading and skill level, it is like using a simulator to learn how to fly an airplane or drive a car before being placed in real—and possibly dangerous—situations. You enter trades, get fills, receive account statements, etc. just as a real trader does and can learn from your mistakes without having to pay real money to gain the experience.
TRADING SUPPORT TOOLS

Charts. Many traders use charts to show them the price history

of a market during different time horizons. Charts allow traders to study what the market has done in the past in similar situations, so they can attempt to discover trading signals and projected targets based on what their analysis suggests for the future. The study of technical analysis is based on interpretation of various chart patterns, and can be very complex. It is often considered an art as much as a science.
Analytical Software. Analytical software provides a wide array of

If you are going to take your trading seriously, you will need more than just a way to enter orders and track your account. There are other resources you will likely need.
Price Quotes. To keep up with the current market status, you will

charts as well as a number of studies and technical indicators, and perhaps even some means to test the performance of a trading method you develop. The studies generally range from simple moving averages to a series of momentum indicators such as stochastics or relative strength. Many are based on the same input—price —so there is a danger of putting too much weight on signals that are similar. System-testing capability gives you an opportunity to try out ideas in market situations without having to use real money to test a theory.
News, Reports, Statistics. Although market technicians would

probably need some type of price quotes updated on a regular basis. How much data you need and how often you get it will depend on the type of trader you are and the amount of money you are willing to spend. Real-time streaming quotes are up-to-thesecond prices updated continuously by the exchanges. They may be reported tick-by-tick or only when there is a change in prices, depending on the quote service. Based on your level of trading activity, these quotes usually involve monthly exchange fees. If you want to be an active intraday trader, you will probably need real-time quotes. In some cases, exchanges offer real-time quotes at no charge to encourage trading in a market, typically for a new contract or for an area that the exchange is promoting. Real-time delayed quotes provide the same information as realtime quotes, but are delayed by 10 to 30 minutes. If you are a highly active day-trader, this time lag probably won’t be acceptable. However, if your approach is longer-term in nature and doesn’t require trading decisions be made down to the second, delayed quotes may be sufficient. Delayed quotes will also save you some money as well, as they currently do not have exchange fees. Snapshot quotes are live quotes but are available on a refresh basis only every 10 minutes or so. Like delayed quotes, snapshot quotes may be all you need if your trades are not highly time sensitive. End-of-day quotes provide the open, high, low, and closing prices for each day. This is a basic quote service used for some trading systems that provide only one signal based on a day’s trading activity.

say prices respond to signals on charts, the underlying force for any significant market movement comes from fundamentals such as supply and demand. Often, these are revealed in government reports and statistics that have scheduled release dates. You need to be aware of these key dates and the numbers other traders and market analysts are forecasting to help you determine how the market might react to them. An unexpected event can also cause extreme price fluctuations, especially in the short-term. You need to have a news source that can keep you apprised of these events in a timely manner so you can analyze how you might want to position yourself—or perhaps more important, not position yourself—in a volatile market environment. By the time you read about a market-moving event in the newspaper, it may be too late, and television news reports may be too brief and shallow to help you as a trader, assuming the event has caught the news department’s attention to even be mentioned. News services that can provide key market-moving information are available online and may be provided by your broker or as an addon service for a fee. Like price quotes, the cost usually depends on whether you receive the news reports real-time or delayed, and whether you need a specialized service that covers a particular market in depth.

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Lind-Waldock Web Site and Lind eWire. The Lind-Waldock Web site is rich in educational resources.

OTHER EDUCATIONAL RESOURCES

An essential resource for one trader may be impractical for you. The key point is not to accumulate resources, but to find those that can help you most as a trader. And that is for you to decide!
Dave Howe is Director of Sales with Lind-Waldock. He can be reached at 800-445-2000 or via email at dhowe@lind-waldock.com for more information about this topic or others.

As a self-directed trader, you want to take advantage of all the resources you can. Here at Lind-Waldock, we offer many means of educational support, including online courses and articles via our Web site, timely trading ideas from Lind Plus brokers in our free weekly “Markets on the Move” webinars, as well as our monthly Lind eWire newsletter. As a self-directed trader, you may not need anyone else’s advice on what or how to trade. Even if you don’t plan to use anyone else’s recommendations, it can be helpful to listen to what a broker or analyst is suggesting for several reasons. It can help you understand what other traders are thinking and how they might be reacting to the same type of market developments you are watching. You can compare someone else’s trading decisions with your own. You may even take a recommended trade because the analyst who presented it has probably done more research, considered more inputs than you have, and has formed a good case for making the recommendation.

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Types of Stop Orders: A Tutorial
BY KRISTINA ZURLA LANDGRAF

Stops can be a valuable tool in your risk-control strategy and allow you to execute your trading plan without the stress of constant market-monitoring. Here we take a look at what stops are, and how to use them.
There is no surefire way to eliminate risk in any investment, but finding ways to alleviate as much of it as you can is vital. Stops can be a valuable tool in your risk-control strategy and allow you to execute your trading plan without the stress of constant marketmonitoring. Here we take a look at what stops are, and how to use them.
STOP ORDERS AS LOSS-LIMITING ORDERS

An open order is good until cancelled or filled, or until the product goes off the board; that is, the contract has expired and is no longer available for trading. A day order is good only for the regular trading session during which it is placed, or for the next session if placed in between sessions. All orders are assumed to be day orders unless otherwise specified.
DIFFERENT TYPES OF STOP ORDERS

Commonly referred to as a stop loss, stops are often used as losslimiting orders. You indicate that you want to get out of the market at a specified target price level if the market trades at or through that price. Buy stops are placed above the market and become market orders if the market trades or is bid at or above your stop price. Sell stops are stops placed below the market and become market orders if the market trades or is offered at or below your stop price. It’s important to note that there is no guarantee that losses will be limited to the desired amount. There can be market “gaps,” or dramatic price movements that result in losses substantially higher than the amount targeted with the stop-loss order. The market has traded through your price—but perhaps much farther and faster than you had planned.
STOP ORDERS AS PROFIT-PROTECTION VEHICLES

Stop Limit (STL). A buy-stop limit becomes a limit order at the

stop price when the market trades or is bid at or above the stop price. A sell-stop limit becomes a limit order at the stop price when the market trades or is offered at or below the stop price. The stop and limit are the same price. These orders are designed to eliminate slippage on stops. However, they may come back “unable,” which simply means they are not able to be filled, and cannot be considered as protection in fast-moving markets. This is not a common order type in open-outcry markets, but may be almost a necessity on some electronic markets that are not very liquid.
Stop With Limit (STWL). This order type is similar to a stop limit in

that a limit price is established. However, the limit on a “stop with limit” is different from the stop price, and provides some allowance of slippage. Once the stop is elected, the order works as a limit order, and as is the case with the stop-limit order, may come back “unable.” Therefore, it cannot be considered as protection in fastmoving markets. Although created for use in open-outcry trading, these orders are most functional on electronic platforms that accept them. This order is useful when you want to place limit orders slightly above the market on buys and slightly below the market on sells. The additional room to fill the order may eliminate missed market opportunities. However, it’s recommended you check with your broker before using this order type actively.

Although stops are most commonly used to exit a losing position, they can also be used to protect profits or to enter positions as markets move into territory considered a favorable entry point. This can help you execute trades at desired levels automatically. Keep in mind, although stops become market orders when elected, they can be subject to what’s known as “slippage.” Slippage occurs in fast-moving markets when stops are filled at prices worse than the stop price. In addition, in markets with price limits in effect during highly explosive periods, stops may be unable to be filled. A stop placed as an open order, known as “GTC,” short for “Good Until Cancelled,” may be unable to be filled for several consecutive sessions if the market is in a limit-up or limit-down situation, but will be filled at the first available opportunity.

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Stop Close-Only (SCO). This is a stop order that will be execut-

able if the day’s closing range is at or through your stop price. There is no reference point to determine if this is a “good” order and, as such, it can be placed at any price within the day’s allowable range. If the market has no limit, there are no such restrictions within reason. You would use an SCO when you do not want a stop order to be activated during the session but do want it to be activated if the market trades at your stoporder level during the closing price range. This order helps you avoid being taken out of a position on a stop that might be hit during intraday price fluctuations. Of course, there are many other types of orders you can place and strategies you can use to help you manage your trading risk while executing your plan. We encourage you to work with a Lind Plus market strategist to find out more. The Education Tab on our Web site also contains more information on order types.
Kristina Zurla Landgraf is Content Manager at Lind-Waldock.

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MOVING AVERAGES EXPLAINED PIVOT-POINT TECHNIQUES THE VALUE OF FAIR VALUE BUILDING YOUR CME E-MINI ® FUTURES TRADING STRATEGY THE BRILLIANCE OF GANN IN TODAY’S MARKETS WHEN TRENDS AREN’T YOUR FRIEND: HOW TO APPROACH DRAWDOWNS THE COMMITMENTS OF TRADERS REPORT: A CLUE TO WHO’S MOVING MARKETS

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Moving Averages Explained
BY DAVE HOWE

A moving average smooths out “temporary “price fluctuations and can help give you a clearer interpretation of which direction the market is moving.
I expect you’ve heard the term “moving average.” And, I expect you may have wondered what it is, or how to use it. This article is intended to answer both of these questions, and add to your trading knowledge. Simply put, a moving average is the average value of a commodity or futures contract’s price over a specific period of time. Moving averages come in different forms. Two of the more common are: The Simple Moving Average (SMA) and the Exponential Moving Average (EMA). Now that you have the definition of a moving average, let’s consider the question, “Why would you want to use a moving average?” It’s very simple. A moving average smooths out temporary price fluctuations and can help give you a clearer interpretation of which direction the market is moving. The use of short-term and long-term moving averages is really a matter of personal preference. Short-term moving averages tend to be very sensitive to price movements, whereas the long-term moving averages are less sensitive to these same movements. Take a closer look at the two we are discussing.
SIMPLE MOVING AVERAGES

is the same calculation whether you are working from 5-minute bar charts or end-of-day charts. The periods of time are different. With the 5-minute bar chart, you are calculating the moving average based on the average closing prices of 10 5-minute periods. With the end-of-day charts, you are calculating the moving average based on the average closing prices of 10 daily periods. As we mentioned before, you can choose to use these moving averages on different types of charts. You are not limited to 5-minute or daily. Traders use many different types of charts. Examples might be 1-minute, 5-minute, 30-minute, 60-minute, daily, weekly and even monthly. It’s worth noting one more time that moving averages can be calculated for any given period of time. Day traders and other shortterm traders may wish to use a moving average based on minutes rather than days. For instance, if you are planning to trade the market, trying for small intraday profits, you might use 5-minute bar charts. In this case instead of using the closing price for the day, you are using the closing price for the last 5-minute period of time. Typically, the most common or standard moving averages for traders are the 4-, 9- and 18-period moving averages, but again, any time period could be selected. When reading a chart, moving averages show up as an unbroken line making it easier to see the “trend” of the market. The chart on the following page illustrates a daily bar chart. In this case, we chose a less conventional 10-bar and a 30-bar moving average of the June 2004 S&P 500 futures contract. When the 30-bar moving average makes a significant turn or bend, it has more credibility as an indicator of change in the direction of the overall trend than does the 10-bar. You see fewer false changes in direction using a longer period moving average than the shorter period. Conversely, the shorter period moving average, being more sensitive, will at times give you an earlier indication of change indirection.

We’ll begin with the simple moving average. We said that a moving average is figured by “averaging” the price over a selected time period. Let’s say you have selected a 10-period, sometimes called a 10-bar moving average for the June S&P 500. To find this moving average, you add together closing prices of the June S&P 500 for each of the last 10 periods and then divide the total by the number of periods—in this case 10. With each new period, you drop the oldest closing price and replace it with the new one. The result is the moving average for the last 10 periods. Notice that in the example, we did not say 10-minute or 10-day moving average, we said 10-period moving average. This is important because the type of moving average you choose will work differently across different time frames. A 10-bar moving average

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Daily Bar Chart: June 2004 S&P 500

EXPONENTIAL MOVING AVERAGES

Once you have the smoothing constant (K), you can calculate the rest of the moving average. First, you subtract the previous period’s EMA (P) from the current price (C) and multiply the difference by the smoothing constant (K). Finally, you add back the previous period’s EMA (P) to get the new EMA. Exponential Moving Average Formula Step 1. K = 2 / (1+N) Step 2. X = (K x (C - P) + P

One of the drawbacks of the moving average is that it is a “lagging indicator.” You can only see what happened in the past. To help compensate for that, traders constructed the “Exponential Moving Average.” The exponential moving average gives more weight to the most recent data, hopefully giving an even more timely indication of market direction. In the exponential moving average, or exponentially weighted moving average, the amount of weight given to the earlier data is dependent upon the length of the moving average used. For example, the shorter length moving average (i.e., a 3-, 4-, or 9-period) gives a higher weight to the more recent data than the longer length moving average (i.e., the 10-, 18-, or 30-period). This makes the shorter-period moving averages react more quickly to recent data than the longer-period moving averages. To calculate the exponential moving average, you apply a smoothing constant to the equation. The smoothing constant (K) is derived by dividing the number 2 by 1 plus the number of periods in the moving average (N).

It is important to note, that when calculating the moving average for the very first time, you will not have an exponential moving average, so you’ll need to use the simple moving average for the first calculation and the EMA thereafter.

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HOW TO USE THEM

There are a number of different ways to use moving averages. Many traders choose to combine a short-term moving average with a longer-term moving average. Generally when the short-term moving average crosses over the longer-term, this is considered contrary to the longer-term trend. This indicator is called a “Crossover.” Others choose to create a band or “Envelope” around the moving average by drawing parallel lines both above and below the moving average line. These parallel lines are set at a percentage away from the line, which indicates the normal distance the price will move above or below the average before gravitating back towards the moving average line. The general feeling is that if a market trades through one of these outside bands it is a very strong indicator of future direction of the market. These are just a few examples. What you’ve learned here is just the tip of the iceberg as it relates to moving averages, and for that matter all technical analysis. Most traders begin by learning the basics, combining and adding additional indicators, filters and rules into the mix resulting in a complete trading methodology. Your next step should be the discovery of these additional tools. A great way to get started on your education is to visit our education site at www.lind-waldock.com/edu. If you’d like help, Lind-Waldock has a team of market strategists who are happy to help you get a jump-start on your education. Feel free to call us at 800-445-2000, and we’ll pair you up with a mentor to help guide you.
Dave Howe is Director of Sales with Lind-Waldock. He can be reached at 800-445-2000 or via email at dhowe@lind-waldock.com for more information about this topic or others.

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Pivot-Point Techniques
BY JEFFREY FRIEDMAN

Pivot points sound like they could be critical junctures in the market, and for some active traders looking at intraday charts, they are. In fact, just because these traders look at pivot points and respect them may be exactly the reason they often work.
PREDICTING PRICES USING SUPPORT AND RESISTANCE POINTS

Support and resistance (SAR) are first and foremost the most important points to watch in price chart patterns. Finding first and second support points (S#1 & S#2) and first and second resistance points (R#1 & R#2) can help you predict how far prices might climb and how far they might fall before you trade. Let’s find out how support and resistance works and how to use pivot points.
DEFINING SUPPORT AND RESISTANCE
Chart 2: Candles Support Trend

Support occurs when increased demand for a particular futures market builds a floor under that market’s price. A support level or zone appears when buyers miss purchasing a futures contract and vow to buy it later should prices decline to the same, or nearly the same, level.
PLAYING THE PIVOT

Pivot points sound like they could be critical junctures in the market, and for some active traders looking at intraday charts, they are. In fact, just because these traders look at pivot points and respect them may be exactly the reason they often work. That is, they may be a self-fulfilling prophecy because so many traders know about them and trade or fade the same numbers. A price bar represents all the prices traded in a specific time frame for a particular market, and a pivot point is a computed number based on a price bar’s high, low and close. From it, support and resistance levels are calculated that act as sort of a bracket for the next price bar’s action.

Chart 1: Suupport and Up Trend

USING PIVOTS FOR SUPPORT AND RESISTANCE

Pivot levels show support and resistance points that can be used for day trading or swing trading. Day trades are those that last for less than one day, while swing trades last between one and Resistance occurs when selling pressure stops a market’s price rise. A resistance level is similar in that traders buy the futures contract just before it tumbles and they vow to sell if its price reaches their purchase price. A common mantra among novice traders is, “as soon as I get my money back, I’m selling.” SAR comes in many flavors, and we’ll discuss the most important one to us: pivots. A special mathematical formula calculates three numbers using the high, low and closing price data with volatility, which shows momentum. These numbers come from a proprietary formula. five days.

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Pivot Table: April 3-7, 2006
Commodity High Low Close R1 R2 Pivot S1 S2

SPM6 US$M6 DJM6 NQM6

1319.00 90.08 11365 1737.50

1300.50 88.96 11162 1683.00

1303.30 89.39 11195 1720.00

1314.70 89.99 11319 1744.00

1326.10 90.60 11444 1768.00

1307.60 89.48 11241 1713.50

1296.20 88.87 11116 1689.50

1289.10 8836 11038 1659.00

The basic pivot technique involves trading with support and resistance levels derived from the previous day’s or week’s (what ever time period you want to use) high, low and closing prices. The idea is to sell when price violates these levels on a break and buy when price pushes through them on the upside. Because former resistance becomes future support and vice versa, these levels provide key stop-loss levels. For example, if you sold when the market broke through support level one, you would immediately place your stop at or just above the support level one price. If the price continues to drop, you can follow the market with a trailing stop. Although these levels sometimes will provide valid support and resistance levels throughout the time period you use, their significance diminishes as they are repeatedly violated. The first time is the most important.

So, what do you have when you apply pivot-point lines to your chart? Active traders treat them like support and resistance levels, acting as potential boundaries for the next bar’s price range. Or, if prices do break through S#1 or R#1, a stop might catch a move to the next target, the S#2 or R#2 line. The support and resistance lines may turn back prices because that’s as far as market strength or weakness can take them or because so many traders expect that to happen, but these lines aren’t walls. What may be more important is how prices react as they approach or break through these lines. When prices are attacking the R#1 and R#2 resistance lines consistently, the bullish trend is entrenched; when prices back away from the R#1 and R#2 lines, the bullish trend is weakening. Like many things about price charts, pivot-point analysis isn’t perfect. It helps if the pivot-point lines coincide with prior highs or lows, chart patterns, candlestick analysis or other corroborating evidence. However, pivot points can be another effective trading tool for your arsenal.
Jeffrey 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.

Chart 3: Silver Pivot Point

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The Value of Fair Value
BY KRISTINA ZURLA LANDGRAF

Simply put, fair value shows the relationship between a stock index futures contract and the underlying cash stock index. It’s a tool that can help traders determine whether the futures market may be over- or under-priced in relation to the cash market.
Savvy traders use every piece of market information to their advantage. Fair value may be one piece of information you’ve overlooked, but it can enhance your stock index futures trading strategy if you do a little homework. You’ve probably heard about fair value, but what is it, and how can it enhance your trading? Simply put, fair value shows the relationship between a stock index futures contract and the underlying cash stock index. It’s a tool that can help traders determine whether the futures market may be over- or under-priced in relation to the cash market. Lind-Waldock calculates fair value daily for clients on our Web site (using three different interest rates) for the front three months of the Standard & Poor’s 500 Index and the Dow Jones Industrial Average. Go to the Trading Tools tab at www.lind-waldock.com for detailed calculations. Fair value, or fair basis, shows how far the futures contract should be trading above or below the cash index given expected dividend income for the stocks in the cash index, the days to expiration for the futures contract and the short-term interest rate. If the futures’ price moves far above or below the fair value premium band, index arbitragers typically will execute trades which will bring the cash and the futures prices back into line. Fair value refers to the spread between the index futures and cash index price, or where futures should be “fairly” priced. To most of the large institutional traders, when the spread is at fair value, owning stock index futures or individual equities that make up the cash index doesn’t make much difference. However, when the spread between the index futures and cash index falls below fair value or moves above it by a large enough margin, then one alternative (stocks or futures) will become more attractive than the other, and they will sell one and buy the other. If futures are sharply above fair
Kristina Zurla Landgraf is Content Manager at Lind-Waldock.

value, market participants are expecting the cash index to move higher, and if they are below, lower. That’s information you can use. “In general, fair value works as a filter,” said Dave Lerman, associate director, index products at the Chicago Mercantile Exchange. “If the S&P futures are supposed to be trading at a 0.6-point discount (to the cash), and you are buying at one-point premium, it will negatively impact your execution and take away your profit potential,” he said. Lerman noted one pitfall traders should avoid— putting in orders too soon when they see the futures well above or below fair value. If you see this happening, chances are, so will others. The big arbitrage players will move at lightening speed to help cause the markets to move back in line. “If you see futures are rich, wait a few seconds until fair value reasserts itself, then go ahead and buy,” he said. The concept of fair value isn’t just valid for the market’s opening; once you make your basis calculation of what fair value should be, it’s good all day, barring any extreme interest rate or dividend fluctuations. Even if you don’t plan to use fair value in your trading strategy, traders should be aware of fair value for another important reason. All domestic stock index futures products at the CME are settled to fair value at the end of every month. This is to alleviate any “tracking error” associated with the fact futures markets are open 15 minutes later than the cash stock markets. So if you have a position on at month-end in these markets, you’ll want to know where you stand.

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Building Your CME E-Mini Futures Trading Strategy
BY LIND-WALDOCK

CME’s popular E-mini index futures trade more than a million contracts per day. Why is this important? And why are E-minis attractive products?
®

Dan Gramza, president of Gramza Capital Management, discusses the basics of CME E-mini futures trading and how to develop your own trading strategy for any market using popular technical analysis methods. View a full online presentation, by Dan, co-sponsored by CME, in our Events area archives at www.lind-waldock.com. It’s free to view and illustrates the concepts presented here and others in more detail. Following is a summarized excerpt from his presentation, edited by Lind-Waldock. CME’s popular E-mini index futures trade more than a million contracts per day. Why is this important? And why are E-minis attractive products?
Liquidity. The marketplace in general has accepted this market.

Other Advantages. There are tax advantages to trading futures

contracts. There is no margin interest. There is no inventory required for short positions, and there is no payment of short position interest.
TYPES OF TRADING

Determining your trading time frame is an important element in determining your trading strategy. We have four possible time frames.
Scalping. Looking at a tick or two in terms of a trade. Day Trading. Exiting positions before the end of a session. Swing Trading. Holding a position from one to 10 days.

Traders like you and me, private traders, institutional traders and investors, are now participating in this market worldwide. It means you and I can enter and exit our trades easily (liquidity). It means a tight bid/ask spread, which is going to reduce our cost of trading.
Capital Efficiency. Don’t let the name E-mini fool you, each con-

Position Trading. Holding a position longer than 10 days.

These elements, these time frames, are important. They create demands. If you are a scalper or day trader, your technology requirements are going to be very high. You have to make sure you have accurate, up-to-date, up-to-the-second information. Where you get in and where you get out of a trade as a scalper and day-trader is essential in terms of your success. And, do you want to sit behind a screen during the day? If you have the time to do that, day trading might be appropriate for you. But if you work another position (job), it might not be appropriate.
SELECTING A TRADING TECHNIQUE: JAPANESE CANDLESTICK

tract controls thousands of dollars of stock. In fact, the only thing that is mini about these markets, is the capital required to trade them. Compared to stocks or ETFs (exchange traded funds), you only have to put up a fraction of the amount of margin.
Virtually 24-Hour Trading. Virtually 24-hour trading is one of the

things I find attractive about this product. It means you can express your opinion about our stock market even when the stock market is not open. We also see those opinions expressed around the world, from Asia to Europe.
Central Marketplace. Also, I think an advantage of this market-

A Japanese candlestick chart uses four prices: the open, the high, the low and the close. A box is drawn between the open and the close. If that box is white, it means the closing price is higher than the opening price. If the box is dark, it means the closing price is lower than the opening price. Instead of calling it a box, the traditional term is the body of the candle. If it’s a white body, that means it’s a buying body; it represents buying behavior coming into the market. It it’s a dark body, it represents selling behavior coming into the market. Also, you and I know the open and the

place is that it’s one—one central marketplace—the CME. If I trade stocks, they can trade on the American Stock Exchange, the New York Stock Exchange, or regional exchanges.

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close, and the high and the low, don’t always match up…that difference between the open and the close, the high and the low, will be represented by a vertical line. That vertical line is called a shadow. Pay attention to the size, pay attention to the body color, pay attention to the body size, pay attention to the shadows. Do you see shadows on the top or bottom? And how big are they? They all give us a measure of the degree of the buying or selling coming into the market. When you look at a candle chart, you want to take it apart.
SELECTING A TRADING TECHNIQUE: STOCHASTICS

There are some critical questions you need to ask when developing your trading strategy. One is your profit objective. How do I determine my profit expectations for this trade? We are going to do some research, that’s how we get answers. Find out, if I did this trade every time in the past, what the range of my profits might be. What was the minimum to the maximum? I put my profit expectations in line with what the market can give me. And, how much do I have to risk? How much heat should I take in this trade? Take a look at profitable trades, and break them into categories. Calculate a “heat index.” Heat is based on volatility and trading characteristics of the market. So, if you have an idea of how much heat you are going to take, and how much profit you can (potentially) make, you have to decide if these balance out. Is the risk/reward appropriate? What are the chances of this trade not working? What is the probability this trade will be profitable? It’s also important to think about other factors, such as trade duration, and trade frequency. How patient should I be? How often can I expect to see this trade? Is it stable in different trading environments, a trending market or a sideways market? Can we consistently take something away from this market, or do we see some weaknesses? In a downtrending market, maybe it doesn’t work so well. We want to identify that. We want to know, is this trading strategy robust? We don’t want to ask something from a trading strategy it can’t give us.
EVALUATE YOUR STRENGTHS AND WEAKNESSES

Stochastics is a study, a measure of market momentum. It indicates when prices have gotten high enough to attract sellers, and it also indicates when prices have gotten low enough to attract buyers. The underlying theme, the concept behind this, is that it’s based on the premise that as prices trend higher, the closing prices have the tendency to close near the highs. And when prices trend lower, the closing prices have the tendency to close near the lows. Normally displayed below a price chart, you’ll see a stochastics scale that goes from 0 to 100. It is supposed to measure “stretchiness” in the market. We use 70 and 30 as guidelines. If this indicator trades above 70, that means it’s getting potentially stretched to the upside. The term used is “overbought.” If it’s trading below 30, instead of saying “stretched to the downside” we’d say “oversold.” These indicators make up two signal lines. A sell signal occurs when the two signal lines move above 70 and cross over, or if the two lines move below 30 and cross over, that would be a buy signal.
COMBINING TECHNIQUES TO CREATE A TRADING STRATEGY

A part of our trading strategy process is the trading decision process we go through. Let’s think about what we do when it comes to putting on a trade. The first thing we have to do is identify the trade, the second thing we have to do is evaluate the trade, the third thing we have to do is execute the trade, and the fourth thing we have to do is manage the trade. We have to manage it from a profit and loss perspective, and we also have to manage ourselves. One of the things I like to do is to ask myself: Where am I the strongest? Where am I the weakest? Look at that closer. What am I going to do about it? If I have a tendency to hesitate when it comes to executing a trade, what does that tell me? Why do you and I hesitate to do anything in life we feel we should be doing? We aren’t that confident, we aren’t that sure what we are going to do next. But if I know that by following some of the elements we talked about, if I know how much patience, then I have a way of increasing my confidence and comfort when it comes to making a trade.
Dan Gramza is President of Gramza Capital Management.

Let’s take these two techniques and create a trading strategy. We are going to enter a trade if two conditions are met. First, we are going to buy a higher high of a Japanese candle rejection pattern. What I mean by a rejection pattern is a small body, with a large shadow in the body. The second condition that needs to be met is that the stochastics signal is below 30 and crossing over. If we have that crossover below 30, and we have a Japanese candle rejection pattern, we are going to buy a new high of that particular candle. Our exit for this trade is that we are also going to trail our stop below the lows of the following candles. And in this case, we are going to stay in the trade until we trade the lower low for more than three ticks.

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The Brilliance of Gann in Today’s Markets
BY DAVID BURTON

The Gann system is the one I prefer to use in my own trading for predicting cycles, markets and trends. It can give you a roadmap of the markets—if you take the time to unlock its secrets.
Born in 1878, W.D. Gann was one of the pioneers of technical analysis and one of the most successful traders of his time. His concepts and techniques still apply to trading today. Gann was foremost a financial astrologer and spent countless hours studying cycles, numbers and Gematria to predict not only movements in stock and commodity markets with great success, but also horse racing and the Cuban lottery. The Gann system is the one I prefer to use in my own trading for predicting cycles, markets and trends. It can give you a roadmap of the markets—if you take the time to unlock its secrets. Gann had become somewhat of a legend even before his death in 1955 for his predictive abilities. He forecast the exact top and price in the cotton market on September 8, 1927, (in his book Tunnel Thru the Air) and it’s even said he predicted World War I in 1914 as well as the resulting panic in stocks. He was often correct about commodity market trends back in the 1920s and 1930s, and his track record of winning trades was extraordinary indeed. He had accumulated more than $50 million until his death, an impressive sum for that era. Gann believed to successfully trade the commodities markets, you must follow a defined set of rules, never to be violated. His “28 Valuable Rules” are still valid for traders today, and I read them every day. Usually when I’ve been unsuccessful trading, I’ve found it’s because I’ve broken one of the rules. I’ll outline a few of Gann’s 28 rules in this article, but I encourage you to seek out and study all of them further.
HISTORY ALWAYS REPEATS

big cycles, the great cycles, are where the most money has been made, so follow the main trend. He studied the CRB Index (a commodity index), the Dow Jones Industrial Average and the bond market, which he felt were the three main indicators for boom-and-bust cycles in the economy. He pored over data back to 1259 A.D. in the wheat market and back 400 years in the cotton market. He used wheat to predict war periods—he found when wheat was booming, there was usually war.
HEALTH, KNOWLEDGE, MONEY MANAGEMENT, CAPITAL AND PATIENCE

Gann’s 28 rules are based on these five things. Gann believed that you are what you eat, and because he studied long and hard, he wanted to have a very alert and astute mind. He was very healthconscious and did not smoke or drink. Gann felt one should never trade when sick or stressed, because your judgment becomes impaired and you make the wrong choices. When that is the case, it’s time to take care of yourself and go on holiday to rejuvenate your body and mind. Gann also believed you can take away all a person’s money, but not his knowledge. So, you must gain understanding of the markets before you trade. If you are starting out, it will be advantageous to paper trade for a time to see if your system works. You’ll then be a step ahead of everyone else. Study the history of stocks, commodities and interest rates, wars, elections and weather. Gann studied these all of the time. Understand the tools of the trade, and understand the main market cycle you are in. Gann never believed in debt. He felt you should work on being debt-free before you are 45 years old, to save and prepare for retirement. You should also have at least a year’s wages in the bank in case you lose your job. This was recommended 100 years ago,

Gann wrote: “Time cycles repeat because human nature does not change.” That is really the backbone of much of his predictive market analysis. “The trend is your friend” is truly Gann philosophy at its most basic. Gann always looked at the big picture first and felt if you study the past, the future will become an open book. The

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and is still good advice today. Gann said you should never have more than 5 percent of your net worth in the market, and when trading futures, he recommended you have three times the initial margin per contract. For example, if the initial margin is $1,200 for one contract for soybeans, you would have available per contract a total of $3,600. It is also important to always keep your trading capital separate from your living capital and assets, and never borrow against assets to trade. Save up money for your trading capital. As mentioned previously, trading capital should be no more than 5 percent of your net worth. If you can’t make money out of your trading account, there is no point in throwing good money after bad. Patience is a virtue. Gann suggested that you trade three to four times per year, per commodity. For this, you will obviously need patience and discipline! If you follow Gann’s 28 rules, this will also help you to be patient. Wait for major setups as more money is made in long bull or bear campaigns.
A few more Gann-based rules I live by:

Monthly high and low charts, angles that form from tops and bottoms

Natural time cycles based on the 360-degree master chart Time and price using the square of 9 and 12 charts Seasonal tendencies Market patterns

For an example of Gann cycle analysis, the wheat market showed bearish patterns in 2005. I subtract these large cycles from 2005.
These cycles proved low years in 1645, 1915, 1945 and 1975.

360-year cycle from 1645 points to a low in 2005 (4x90) 90-year cycle from 1915 points to a low in 2005 60-year cycle from 1945 points to a low in 2005 30-year cycle from 1975 points to a low in 2005

Gann never revealed his secrets to anyone unless they did the work, including his own son. His philosophy was basically, work hard and the secrets will come to you. Gann coded his books so his followers would work hard to gain the knowledge contained in them. You can download an eight-page partial decoding of his book, Tunnel Thru the Air at www.schoolofgann.com. Here you’ll also find more information about Gann for further study. As Gann once said, “Knock on the door and it will be opened unto you, seek and you shall find.”
David Burton is Managing Director of Commodity Hedging Company and offers workshops and home study courses on Gann’s methods through his Web site, www.schoolofgann.com.

Always have a maximum 3 percent stop loss Divide your capital into 10 equal parts Only trade trending markets—always leave dead markets alone; trade markets with at least 30 years of data, so you can track long-term cycles

Read Gann’s 28 rules at least once every day, and make sure you don’t break any. They are found on page 43 of Gann’s book, How to Make Profits in Commodities.

GANN’S TOOLS

Gann’s system is highly complex and a lot of his writings were veiled in secrecy. He used a combination of methods to determine future trends of the markets.
These methods include:

Resistance levels made by market fluctuations Geometrical angles Time cycles and time periods (Gann’s cycles were 90, 84, 60, 30, 20, 13, 10, nine, seven, five, three and one-year)

Squaring out price with time from tops and bottoms Odd and even squares and the halfway points between both odd and even squares

Weekly high and low charts, angles that form from tops and bottoms

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When Trends Aren’t Your Friend: How to Approach Drawdowns
BY JOHN TOLAN

With any investment you are going to experience losing periods, and trendfollowing strategies are no exception. How you choose to deal with these drawdowns can be the difference between sleepless nights and confidence in your investment approach.
I’m sure you’ve heard the popular adage that guides many successful traders: “The trend is your friend.” It’s based on the simple philosophy that if you stick to trading the prevailing trend in any market, you’ll have more success than trying to go against it. There are many popular trading systems based on this methodology, with unique variations in their approach. But what if the trend isn’t your friend, and you experience a losing period? What if tradable trends fail to materialize, and/or your trading system is having trouble coping with a volatile period? With any investment you are going to experience losing periods, and trend-following strategies are no exception. How you choose to deal with these drawdowns can be the difference between sleepless nights and confidence in your investment approach. Every time traders or investors go through a difficult period, they tend to ask the same questions: “Have the markets changed? Has trend-following stopped working? Does something need to be fixed? Should I close my account? Should I trade another system?” Before you jump ship, please take a moment to consider your decision from a long-term, trend-following perspective.
DRAWDOWNS ARE NORMAL EVENTS

It’s important to remember these four points.
1. Stick to your trend-trading system. Don’t let a series of losing

trades, in the short run, cause you to lose confidence and deviate from your long-term trading plan.
2. Even the best systems—all systems—generate periods of losing trades and account equity drawdowns. That’s reality.

Just as market prices move in trends, so will your trading equity. That is how the markets work and how trend-trading systems work. Up trends tend to be followed by sideways and down trends. Profitable periods tend to be followed by losing periods, which tend to be followed by profitable periods, etc. It’s what to expect.
3. These equity swings will test your trend-trading discipline.

Don’t get optimistic when you’re making money and add to your position size. This may result in doubling the magnitude of your next drawdown.
4. Don’t let your emotions, whether up or down, affect your long-term trading plan. Have realistic expectations and stick to

your plan. If you can’t accept losses as part of the process, then trend-trading will not work for you. You must be prepared to evaluate your trading performance based on many trades over a long period of time. This discipline is “the key to trading success;” your trading edge.

Of course drawdowns are unpleasant. But, they do not signal that something is wrong with markets, trend following, or the future. History has shown that change is constant, change is random, and trends will appear again if we go through a period of non-trending markets. Choppy, sideways markets are a precursor to future trends, whether they are up or down. Therefore, when you experience this type of action, you can look at it as a waiting period for some possibly dynamic trends in the near future.

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TREND-FOLLOWING ISN’T PERFECT, BUT HAS HISTORICALLY BEEN VIABLE

Like democracy, trend-following has its critics. Trend-following isn’t perfect, but over the long run, many investors have found it to be a viable strategy. You must evaluate your own financial situation and risk tolerance to determine what is suitable for you. If trend-following were a perfect strategy with high returns and no risk, everyone would do it successfully. But trend-following, like all strategies, has its flaws. Volatility. Losing trades. Drawdowns. The reality is that the masses tend not to learn from history, human behavior does not change, and so history repeats itself.
John Tolan is a Commodity Trading Advisor.

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The Commitments of Traders Report: A Clue to Who’s Moving Markets
BY KRISTINA ZURLA LANDGRAF

The Commodity Futures Trading Commission’s (CFTC) Commitments of Traders (COT) Report offers a weekly glance into positions various groups of market participants are taking in the futures markets.
Ever wish you could get some insight into what other traders are doing? How the biggest players, such as large funds and institutions, may be positioning themselves in the markets? The Commodity Futures Trading Commission’s (CFTC) Commitments of Traders (COT) Report offers a weekly glance into positions various groups of market participants are taking in the futures markets. Many analysts use the report to help determine what trends could come next, and it’s a tool you might find useful in your trading as well. The CFTC puts out its COT reports each Friday at 2:30 p.m. Central Time—one for futures and one combining futures and options. The reports contain a breakdown of open interest for markets in which 20 or more traders hold positions equal to or above levels the CFTC has established, as of three days prior (Tuesday) that same week. The categories of participants are grouped into “reportable” and “non-reportable” positions. For reportable positions, data are provided for commercial and non-commercial holdings, spreading, changes from the prior report, percentage of open interest by category and number of traders. A long version of the report also contains information on data by crop year, where appropriate for agricultural markets, and shows the concentration of positions held by the largest four and eight traders. You can go to the CFTC’s Web site at www.cftc.gov to obtain current and historical data. It’s important to know what the CFTC is reporting, so below are brief definitions of some of the terms in the COT. We’ll explore later how some analysts use this data to help determine market trends, and what you might look for.
Commercial and Non-Commercial Traders. When an individual Reportable Positions. Clearing members, futures commission
CFTC COT DEFINITIONS

Open Interest. Open interest is the total of all futures and/or op-

tion contracts entered into and not yet offset by a transaction, by delivery, by exercise, etc. The aggregate of all long open interest is equal to the aggregate of all short open interest. Open interest held or controlled by a trader is referred to as that trader’s position.

merchants, and foreign brokers (collectively called “reporting firms”) file daily reports with the Commission. Those reports show the futures and option positions of traders that hold positions above specific reporting levels set by CFTC regulations. The aggregate of all traders’ positions reported to the Commission usually represents 70 to 90 percent of the total open interest in any given market.

reportable trader is identified to the Commission, the trader is classified as either “commercial” or “non-commercial.” All of the trader’s reported futures positions in a commodity are classified as commercial if the trader uses futures contracts in that particular commodity for hedging, as defined in the Commission’s regulations. The non-commercials, therefore, represent mainly speculators, the large funds. A trader may be classified as commercial in some commodities and non-commercial in other commodities. A single trading entity cannot be classified as both a commercial and non-commercial entity in the same commodity. Nonetheless, a multi-functional organization that has more than one trading entity may have each trading entity classified separately in a commodity. For example, a financial organization trading in financial futures may have a banking entity whose positions are classified as commercial, and have a separate money-management entity whose positions are classified as non-commercial.

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Non-reportable Positions. The long and short open interest

Some traders use COT data to help determine an overbought or oversold condition. If the COT report would show, for example, a heavy long position in a market that has spiked unusually and is high-priced, with high relative strength readings for an extended period, a trader may look to sell. In this sense, the report can be used as a contrarian indicator—a sign the longs may be looking to take profits, and price action could take a turn.

known as “non-reportable positions” are derived by subtracting total long and short “reportable positions” from the total open interest. Accordingly, for “non-reportable” positions, the number of traders involved and the commercial/non-commercial classification of each trader are unknown.
Spreading. For the futures-only report, spreading measures the

extent to which each non-commercial trader holds equal long and short futures positions. These figures do not include inter-market spreading (e.g., spreading Eurodollar futures against Treasury note futures).
Changes in Commitments from Prior Reports. Changes

You can use the COT reports to track historical tendencies and past extremes in net long or short posture for each group to gain some insight into their thinking, and perhaps even their next move. Of course, what’s happened in the past may not happen again, and no one really knows what each group will do. But, the COT data has its place as another tool many traders find valuable.
Kristina Zurla Landgraf is Content Manager at Lind-Waldock.

represent the differences between the data for the current report date and the data published in the previous report.
Percent of Open Interest. Percentages are calculated against the

total open interest for the futures-only report.
ANALYZING THE DATA

So, now you know what’s in the report. But the $64,000 question is—how do you use this information? Most analysts tend to focus on the net position changes from report to report for the various groups. Are the large funds net long this week, or net short? Where were they positioned last week? Many watch where the largest traders with the most assets, or what some call the “smart money,” are entering and exiting trades, because they generally have the most power in terms of moving the market. These typically are the large commercials and/or large speculators, although in some markets, the small speculators may be the ones making the best trading decisions, even if they aren’t the biggest players. It helps to track this data each week, see what each group is doing, and compare the price action to find out who has been on the winning side of the market.

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INTRODUCTION TO FUTURES SPREADS TRADE BY THE BOOK: A GUIDE TO READING ORDER FLOW TECHNICAL ANALYSIS AND OPTIONS STRATEGIES FOR LONG-TERM POSITION TRADERS UNDERSTANDING OPTIONS SPREADS A MOVING AVERAGE THAT CAN MOTIVATE YOUR TRADING: TILLSON’S T3

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Introduction to Futures Spreads
BY KEITH SCHAP

Today, traders on proprietary trading desks and at hedge funds that use futures are almost always in spread positions. Observers call them “relative value traders.”
Since nearly the beginning of the futures markets, traders have used spreads. Today, traders on proprietary trading desks and at hedge funds that use futures are almost always in spread positions. Observers call them “relative value traders.” Any trader serious about the business of trading should consider following the lead of these professionals.
SPREADS DEFINED CALCULATING CONVENTIONS

To make the abstract more concrete, consider an old crop/new crop corn spread—the July/December spread. The July contract marks the end of one crop marketing year while the December contract marks the beginning of the next marketing year. Corn futures quote in cents per bushel (e.g., 253 cents per bushel), but some quote sources convert into dollars per bushel (e.g., $2.53 per bushel).
This spread is most often calculated in terms of new crop minus old crop equals spread. ( New Crop) Dec corn

At its simplest, a spread involves buying one contract and simultaneously selling another related contract.
Some of the more common spreads include:

$2.47 -$2.53 -$0.06

Old crop-new crop corn spreads (or any other agricultural or tropical contract)

(Old Crop) July corn Spread

Crude oil calendar spreads Intermarket spreads such as wheat/corn or platinum/gold Stock index spreads including the E-mini® S&P ® /E-mini® NASDAQ ® spread So, on one day in 2004, the July/December corn spread was at minus six cents. You can set up a spreadsheet to calculate this spread over time and chart the futures prices and the spread, or just the spread. Figure 1 shows this spread. The way Figure 1 focuses on just the spread makes it easier to locate the trading opportunities that existed then.

More complex spreads—such as yield curve spreads, the soybean crush spread, or the crack spread—can also produce solid opportunities, but this discussion will focus on simpler two-contract spreads to introduce the basic ideas. The two parts of a spread—the bought and sold contracts—are called “legs.” The legs of a spread might represent an old crop and a new crop. They might represent inflation fears and estimates of economic growth. Traders expect one leg to lose but the other leg to gain enough to result in a net gain. The point is that one leg will outperform the other in relative terms—hence the term “relative value trade.” I’ll outline a couple of examples of spreads from market activity in 2004 as examples of the concepts.

Figure 1: Corn Spread

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WHY TRADE SPREADS?

Futures buyers gain only when prices rise; sellers gain only when prices fall. Spread traders can gain whether prices rise, fall, or move in opposite directions.
Consider that a spread will “narrow” when:

Spreads attract professional traders for several reasons. For one, spreads contain solid information about supply-demand economics. When supplies are plentiful, or when demand is slack, spreads signal the market’s desire that the new crop, or new production, go into storage. Conversely, when supplies are scant, or when demand exceeds supply, spreads signal the market’s desire for immediate delivery of the goods. These signals occur year-in and year-out regardless of price levels. This makes spreads more predictable than outright prices.

both prices rise but the nearby rises more both prices fall but the nearby falls less the nearby rises and the deferred falls

Further, a spread will “widen” when:

For another, spreads tend to be mean reverting. They rise and fall around a mean level and are extremely unlikely to embark on long trending moves. This tends to make spreads safer to trade than outrights.
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both prices rise but the deferred rises more both prices fall but the deferred falls less the nearby falls and the deferred rises

Be careful with this. A common misconception is that spreads are safe. Spreads are speculative trades. Granted, the burden of the speculation is on spread behavior rather than on price direction, and spreads are typically easier to predict than price direction. Spreads remain view-driven trades, and views can be wrong. In short, while spreads may be safer, they are not safe. A final reason to trade spreads involves margins. In early August 2005, the speculative initial margin for Chicago Board of Trade corn was $675 per contract, in contrast to $135 for the old crop/new crop corn spread. The exchanges list margins and margin breaks on their Web sites but all handle them a bit differently. Your broker can help you make sense of this and also help you with current margin requirements, price quote conventions and the mechanics of spread order placement.
NARROWING, WIDENING, AND SPREAD LOGIC

Professional traders prefer these extra chances to be right. The logic of trading spreads is straightforward. If you expect something to increase in value, you typically want to buy. If you expect something to decrease in value, you typically want to sell. For outright futures, increase in value means rise in price. Decrease in value means fall in price. For spreads, increase in value means spread widening. Decrease in value means spread narrowing. Expecting a widening spread, you typically want to buy. Expecting a narrowing spread, you typically want to sell. So, to buy the old crop/new crop spread in any of the markets where these are relevant terms, you buy the new crop contract and sell the old crop contract. In the case of the July/December spread, you buy December and sell July. To sell this spread, you sell December and buy July.

Rather than worry about the relative safety of spreads, you will do better to focus on the fact that spreads give you more ways to be right.
Narrowing and Widening Table
NARROWING WIDENING

Start

End

Change

Start

End

Change

July Corn December Corn Spread

2.71 2.79 0.08

2.77 2.82 0.05

0.06 0.03 -0.03

2.71 2.79 0.08

2.77 2.88 0.11

0.06 0.09 0.03

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Table 1: One Possible Old Crop-New Crop Spread Outcome
Action Price ($) Action Price($) Result Amount ($)

July Corn December Corn

Sell Buy Spread

2.71 2.79 0.08

Buy Sell Spread

2.77 2.88 0.11

Lose Gain Net

-0.06 0.09 0.03

Table 2: Second Possible Old Crop-New Crop Spread Outcome

July Corn December Corn

Sell Buy Spread

2.71 2.79 0.08

Buy Sell Spread

2.65 2.76 0.11

Gain Lose Net

0.06 -0.03 0.03

Table 3: Selling the Spread in Anticipation of Narrowing

July Corn December Corn

Buy Sell Spread

2.71 2.79 0.08

Sell Buy Spread

2.68 2.73 0.05

Lose Gain Net

-0.03 0.06 0.03

Table 4: Buying the Platinum-Gold Spread in Anticipation of Good Economic News

Platinum Gold

Buy Sell Spread

50,469 50,886 -417

Sell Buy Spread

56,522 51,036 5,487

Gain Lose Net

6,053 -150 5,903

Table 5: Selling the Platinum-Gold Spread on Rising Inflation Fears

Platinum Gold

Sell Buy Spread

52,760 49,706 3,054

Buy Sell Spread

48,823 50,381 -1,558

Gain Gain Net

3,937 675 4,612

AN OLD CROP/NEW CROP CORN EXAMPLE

This time, both futures prices fell, but the July price fell more. Since you initially sold the July, this falling price results in a gain. However, the falling December price results in a loss, and the spread nets the same three-cent gain. The point is that you don’t know which leg of the spread will make money. In Table 1, it was the December leg. In Table 2, it was the July leg. When you trade spreads, you give yourself more ways to be right.

To illustrate the fact that spread widening or narrowing, not price direction, is what matters in spread trading, suppose your market study led you to believe that the July/December spread would widen in the next few weeks. Given this, you might have bought the spread—i.e., bought the December contract and sold the July contract. Suppose the market behaved as shown in Table 1. Both futures prices rose, but the July price rose six cents while the December price rose nine cents. Since you initially sold the July leg, the price increase results in a loss. Still, this widened the spread three cents. You may wonder why bother with the July leg when the December contract on its own would have earned nine cents. Table 2, which has the same starting prices as Table 1, shows the answer.

Spread traders are willing to accept modest gains given strategies that allow these gains to happen more often. Now consider a situation in which you anticipated a spread narrowing. You would sell the spread—i.e., buy the July contract and sell the December. Suppose both prices fell but the December price fell more. This would narrow the spread and generate a gain, as Table 3 shows.

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Always keep in mind that losses can happen if your outlook is wrong. Switch the buys and sells in these examples and see what results.
MARKET KNOWLEDGE IS KEY

Thus when inflation threatens or economic growth slows, demand for gold should increase, and gold should outperform platinum. Conversely, when the U.S. economy seems to be thriving, demand for platinum will strengthen enough that platinum should outperform gold. To calculate this spread, multiply the prices by the contract sizes and subtract the gold dollar value from the platinum dollar value. This spread structure will widen when the economy is strengthening and platinum is outperforming and narrow when the economy is weakening or inflation is threatening and gold is outperforming. You buy or sell this spread in terms of what you do with the platinum leg. Figure 2 shows this spread for the first 10 months of 2004. Consider two segments: from February 2 to March 1 and from May 26 to June 28. During much of that January, economic prospects seemed rosy and auto makers were ramping up production. This could have seemed a good time to buy this spread. Table 4 shows the potential of such a trade. By May, inflation talk had become more prominent, and selling the spread might have seemed wise. Table 5 shows the potential of this trade. Notice especially that both legs gained, not entirely rare with this spread.

Market veterans insist that to trade spreads you must know your markets. You must be aware of the supply-demand situation and of how spreads typically react to factors affecting this balance. Consider the 2004 corn market of Figure 1. This spread narrowed sharply from minus 4.5 cents per bushel on January 9 to minus 19.25 cents on January 28. Here’s why: right after January 9, the USDA reported that corn stocks were far smaller than anyone had thought. When supplies are scant, the old crop price will rise relative to the new crop price to draw supplies out of storage. This narrows the spread. So this might have seemed a good time to sell the spread. Further analysis led the market to fear the world could run out of corn in a few years. This narrowed the spread even more. Note the downward spike in late January. Spread sellers could have earned as much as 14.75 cents per bushel, or $737.50 per one-lot spread, depending of course on where they got in and out. By May planting time, the outlook had changed. Farmers planted more acres to corn than anticipated, planting weather was ideal, and planting was completed early—all omens of a bumper crop. Supply abundance typically creates a strong storage impulse—i.e., the promise of a huge crop will drive the spread wider. So, mid-to late-May might have seemed a good time to buy the July/December corn spread. Figure 1 shows that spread buyers could have earned anywhere from a 15-cent to a 20-cent widening, depending on entry and exit points. Of course a sudden rash of bad weather could have altered the picture, and the spread could have lost. In this case, it didn’t.
TRADING GROWTH AND INFLATION PROSPECTS
Figure 2: Platinum/Gold Spread

A FINAL WORD

The platinum/gold spread is another good example of a spread, and one which shouldn’t be overlooked because it serves as a useful gauge of the U.S. economy. When inflation threatens or when financial investments generate meager returns, gold becomes an inflation hedge or an alternative investment. Though also precious, platinum is more of an industrial metal. Every automotive catalytic converter contains platinum as do fuel cells, spark plugs, computer hard drives, and pollution control devices.

This discussion touches on only two of the many spread trading opportunities that are available in the futures markets. Although an erroneous outlook can lead to losses, spreads are much easier to predict than outright prices. As a result, spread trading strategies can generate a steady stream of modest but gratifying returns to your trading efforts.
Keith Schap is the author of The Complete Guide to Spread Trading. For more information on this topic, go to our Events archives, where you can view Keith’s webinar, “Futures Spreads: The What, the Where, the How and the Logic,” presented August 23, 2005.

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Trade by the Book: A Guide to Reading Order Flow
BY JACK BROZ

If you use technical analysis to determine entry points for trades, you probably have found that many, many times, as soon as you get long—the market breaks. Or, no sooner do you get short—and the market rallies.
The more time I spend working with new traders, the clearer it becomes to me that what these traders are missing in their quest to become profitable is the ability to read order flow. Oftentimes, I find that these traders know more about technical analysis than professional traders who have been making a living in the pits or on the screen for 10, 15, or even 20 years. If you use technical analysis to determine entry points for trades, you probably have found that many, many times, as soon as you get long—the market breaks. Or, no sooner do you get short—and the market rallies. Or, you enter a trade, and just watch the market chop around your entry price for several minutes. (There’s no reward in that trade either). How about exiting trades? How many times have you just gotten out of a position—and the market immediately races your way several more ticks? Bids Now, rest assured that these same things also happen to professional traders; however, they happen to the novice trader so often that the trader finds it difficult to become profitable. I propose that what the novice trader is missing is a correct gauge of the order flow, that is, what the buyers and sellers in the market are doing. I’ve heard many traders refer to what I’m discussing as “timing” as in, “I had the right idea, but my timing was off.” It’s the same thing; a trader who can correctly read the flow of bids and offers into the marketplace will be better able to time his trade entries and exits. I’ll demonstrate an order book for the mini-sized Dow futures with buy orders to the left side, and sell orders to the right. The top price on the left side is the current bid; the top price on the right side is the current offer. The numbers next to the prices in the book show the actual quantity at each price. For example, 42 9736 on the left side means there are 42 orders to buy at the price of 9736. If we see 9737 38 in a row on the right side, we know that there are 38 orders to sell at the price of 9737. However, keep in mind that what you are seeing (when you trade) is the live book and that the prices—and especially the quantities—will continually change. Scan each “tens” columns of bids and offers; it suffices to say that there are more bids than offers in the book. (We would expect this to push the market higher). — — — — — 42 16 22 87 38 Last Price 9741 9740 9739 9738 9737 9736 9735 9734 9733 9732 Offers 40 40 16 18 38 — — — — — Now, what is critical is the volume of the best five bids versus the volume of the best five offers. As you read that, perhaps you’re thinking, “How in the world can I keep up with something that is ever-changing?” Well, first of all, you only need to “guesstimate” the total volume of the best five bids versus the best five offers. If the book shows: (Note: In an exchange-designated fast market, the changes in the book will be even more pronounced. While there are strategies for trading a fast market, the purpose of this article is to introduce traders to the benefits of reading order flow; traders in the beginning stages of learning to use the order book should not trade fast markets.)

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Suppose the book changed to this scenario: Bids — — — — — 39 42 93 43 40 Last Price 9741 9740 9739 9738 9737 9736 9735 9734 9733 9732 Offers 40 33 20 14 28 — — — — —

What we see here is that the buyers have taken all the 9737 offers and bid to buy more. That’s bullish. Furthermore, some of the sellers at 9738 pulled their offers—they are less eager to sell than they were a few seconds ago. That’s bullish—some of the 9736 bids went up to 9737—also bullish. A guesstimate shows the bid size is still larger than the offer side, which is bullish. About the only thing that is bearish is that the size at 9741 hasn’t budged. Two minutes later, the book shows: Bids — — — — — 9 17 22 44 20 Last Price 9757 9756 9755 9754 9753 9752 9751 9750 9749 9748 Offers 55 87 109 50 7 — — — — —

The first thing to look at is the Last Price – suppose 9737 appears there. This change in the order book tells us that 9737 traded perhaps as many as 10 times (the offer volume is 10 less and the offer price traded). We can also deduce that the buyers are becoming more willing to buy; the quantity of 87 that was on the 9733 bid appears to have moved up to 9734; the quantity of 22 previously bid at 9734 appears to now be bid at 9735. Now the book changes to: Bids — — — — — 66 55 40 52 38 Last Price 9742 9741 9740 9739 9738 9737 9736 9735 9734 9733 Offers 16 40 35 11 9 — — — — —

The first thing that jumps out is that now the offer side of the order book has the better size. This is the first hint that perhaps it’s time to take profits. We also see huge size at 9755. That kind of size can be interpreted as longs looking to take profits, institutional sellers anticipating resistance at 9755, or, institutions trying to push the market back down so they can re-establish long positions. Now, please understand that reading order flow is by no means an exact science. However, by studying the order book every day, you will begin to notice nuances – patterns – in the way market participants place orders, pull orders, etc. When you’re watching order flow, you’re watching every market participant – the institutions, hedgers, large speculators, and small traders. On one end of that spectrum are the one-and two-lot traders placing orders in an attempt to establish a trade. On the other end of the spectrum are the institutions and large traders who, besides looking for trades, will use the book in an attempt to bluff other traders. An example of how they might do this is by placing large buy orders and hoping other traders bid in front of those orders. The institution will then sell those bids. In many ways it’s a game of cat-and-mouse that often goes unnoticed by new traders.

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As you learn what is happening in the market by watching the book, combine that insight with information obtained from studying a five-minute chart. Suppose the five-minute chart shows that the market has rallied up to 9775 twice during the session – only to fail and sag back to 9735-38. This tells us that the market is viewing 9775 and 9735 as important areas. The key is to use the order book as trade nears those prices to determine if the market is still viewing 9775 as resistance, and 9735 as support. Continuing with our previous examples, let’s say the market falls back after uncovering the 109 offered at 9755. A few minutes later we see this in the book: Bids — — — — — 66 55 40 52 38 Last Price 9742 9741 9740 9739 9738 9737 9736 9735 9734 9733 Offers 16 40 35 11 9 — — — — —

This tells us that the market is still viewing the 9735 area as support, and we can therefore look to buy this area. You can see the order flow on Lind Xpress®, which offers market depth for both Globex and e-cbot markets, five deep on your screen. You can view number of orders, quantity and price displayed. Lind Xpress is always free to download and use.
Jack Broz is a Chicago Board of Trade member and an independent analyst of U.S. equity and interest rate markets. He publishes daily analysis at www.themarlinletter.com, where he can be reached.

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Technical Analysis and Options Strategies for Long-Term Position Traders
BY KEN SHALEEN

The age-old question all traders face is when to enter a new position. There are three obvious choices for classical chartists: in anticipation of a breakout, on the breakout (a close outside the formation), and after a price pullback toward the breakout.
You might see a pattern unfolding and want to “lead off,” or get into a trade before it actually develops. This can be a mistake—what if the breakout you are anticipating doesn’t happen? But on the other hand, you don’t want to miss out on the trade, or get in too late. You can use an options strategy to help you in this situation. As you see the evolution of a price pattern, specific options strategies may be far more suitable for establishing a position than an outright long or short trade. This is especially true in the futures markets, with their propensity to gap open beyond reasonably placed protective stop-loss orders. Let’s examine a classic head-and-shoulders bottom pattern as an example of a chart that offers potential for an upside market breakout. A head-and-shoulders chart formation resembles a human head and shoulders and is generally considered to be predictive of a price reversal. A head-and-shoulders top (which is considered predictive of a price decline) consists of a high price, a decline to the support level, a rally to a higher price than the previous high price, a second decline to the support level, and a weaker rally to about the level of the first high price. The reverse (upside down) formation is called a head-and-shoulders bottom (which is predictive of a price rally). Any head-and-shoulders pattern needs five reversals of the minor price trend. In a head-and-shoulders bottom, the lows at points one and five are the low of the shoulders. There must be a highvolume close above the neckline to confirm a bullish pattern. Once that pattern is activated, you can calculate your upside objective. The problem is, when we think we have a low on the right shoulder, we get excited about putting on a position, that is, getting long. But if we put that position on too soon, that would be anticipating the breakout, which might or might not occur. We need to wait for a close, until the pattern is fully formed. What we can do in anticipation of this pattern, however, is to use an options strategy.
Head-and-Shoulders Bottom

MINIMUM MEASURING OBJECTIVE

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Neckline

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Right Shoulder
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Left Shoulder
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THE VERTICAL BULL CALL SPREAD

strategy lies in the fact that your maximum loss is equal to your net debit. That is, you are only risking the funds you need to initiate the position. So, which call to sell and which to buy? I would recommend being long the at-the-money option and short the out-of-the-money. This is in anticipation of buying back one-half of the higher strike on the breakout. If the market is trading at 100, you’d be long the 100 call and short

To anticipate an upside breakout with a limited loss potential (but also a limited reward potential) you can initiate a vertical bull call spread. You would buy the lower strike price and sell the higher strike price of the same expiration month. Conversely, if you see a possible head-and-shoulders top forming and expect the market to fall somewhat, you’d initiate the opposite lead-off options strategy—a vertical bear put spread where you’d buy the higher strike price and sell the lower of the same expiration month.

RISK REWARD PROFILES AT EXPIRATION

the 102, or for a more aggressive approach, short at 104. This is more aggressive because the maximum reward is only realized (assuming no lifting of legs) if the underlying instrument is trading above the upper strike (at expiration). If you look at the diagram, the letter “C” on the chart would be the at-the-money option, say at 100, while the “A” strike would be out-of-the-money 96 and the “E” the in-the-money at 104.

+ –
Long ITM Call “A”

Short ATM Call “C”

You can go back to your head-and-shoulders chart pattern to find
Short OTM Call “D”

out what strikes you might want to use, based on your projected breakout target. This is shown on the diagram by moving the vertical distance of the pattern over to the price at the neckline break. Keep in mind, objectives for head-and-shoulders patterns are minimums; the breakout could exceed your expectations. A wise

+ –
Long ITM Call “B” Short OTM Call “E”

strategy is to take profits you might realize on one-half of your position, then let the rest ride until the charts tell you the outlook has changed. Look at open interest for clues also; see where it’s concentrated. And use a trailing “mental” stop on the price chart of the underlying instrument to help you lock in any gains.

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Long ATM Call “C”

A benefit to this type of long-term approach to trading is that unlike a short-term trader, you don’t have to be glued to your screen all day, and you don’t need to pay for real-time quotes.

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A Risk=Amount Paid B

Reward and Increasing Price of Underlying Instrument C Current Price D E

This is just one strategy you can consider when using technical analysis. There are many more options strategies you can incorporate depending on your viewpoint, the type of chart pattern you see, and at what stage the pattern appears to be.
If you are interested in this or other options strategies, please speak to one of our Lind Plus brokers, who would be happy to assist you. Ken Shaleen is President of CHARTWATCH and a frequent instructor at CME. To find out more about Ken’s weekly technical research, go to www.chartwatch.com

Note the maximum profit is realized if the price of the underlying is at or above the higher strike expiration. The maximum loss is recorded if the underlying is at or below the lower strike at expiration.

The options strategy is a debit transaction, with your breakeven point the lower strike plus your net debit. Your maximum profit equals the higher strike minus the lower strike minus the net debit. If you are willing to consider a lower possible reward (versus an outright long in the underlying instrument), the advantage of this

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Understanding Options Spreads
BY ADAM KLOPFENSTEIN

The premise behind them is that they have defined risk and limited profit potential but can be used to get closer to the actual futures price of the underlying commodity.
Option spreads are a great way to take part in an upward or downward trending market. The premise behind them is that they have defined risk and limited profit potential but can be used to get closer to the actual futures price of the underlying commodity. An example of an option spread in the soybean market, where outright options are very expensive due to the volatility, would be to buy the November soybean $7/ $7.60 bull call spread. Here you are buying the call option closer to the money ($7 call) and selling the option that is further away ($7.60 call). Part of the cost of buying the $7 call is “financed” by the sale of the $7.60 call. If you wanted to buy a $7 call option on the November soybeans outright, it would cost you 34 cents (each cent in the beans is $50), or $1,700 per option. The maximum risk is the $1,700 you pay (not including any commissions or fees) and the profit potential is infinite above $7 plus the 34 cents you paid for the option (breakeven is $7.34). However, if you initiated a $7/ $7.60 call spread, the cost would only be 15 cents, or $750. The advantage of a spread is that you can get closer to the underlying commodity price for less cost. However, the disadvantage is that your profits are capped at the difference between the two strike prices (in this case 60 cents, or $3,000 exclusive of commissions or fees). While the profits are not unlimited as they are with an outright option, it is rare that a market goes straight up or down. A spread can offer a better chance of having your long option in the money as you can get closer to the underlying commodity for less out-ofpocket cost. While option spreads can be an effective way to play a market move up or down, there is a tradeoff if the market were to move past the further-out call. In this case you would miss out on any potential profits above the strike price that was sold to “finance” the closer-to-the-money call. This same example can be used to position an account for a move lower in price through a put spread.
Adam Klopfenstein is a Senior Market Strategist with Lind Plus. You can reach him at 800-266-0551 or via email at aklopfenstein@lind-waldock.com.

This can be done by purchasing a put closer to the underlying commodity price, while selling a put further away from the current commodity price. If you need any more information or explanation on the use of option spreads please feel free to contact me.

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A Moving Average That Can Motivate Your Trading: Tillson’s T3
BY STEVE KARNISH

Many traders who have been exposed to Tillson’s T3 agree that it is a moving average that is a better tool than most simple, weighted or exponential averages.
Moving averages have always been a favorite tool among technicians. I have used moving averages since 1975 and believe that a good moving average can: a) define the trend b) act as support and resistance and c) be used/configured as a momentum oscillator. Over the years, I have seen many attempts at constructing a “better moving average.” I’m sure you’ve heard of 20-day, 50-day and 200-day moving averages. After testing and examining hundreds of algorithms, I would like to share with you the one moving average I use every day to guide my trading. Three years ago, I met Tim Tillson. Tim wrote a great article in the January 1998 issue of “Technical Analysis of Stocks and Commodities” titled: “Better Moving Averages.” Many traders who have been exposed to Tim’s work agree that he has designed a moving average that is a better tool than most simple, weighted or exponential averages. Tim’s goal in constructing the T3 was to remove random noise from the underlying time series (your favorite stock or commodity). His moving averages exhibit very desirable characteristics. The T3 is an adaptive moving average that is smooth, but is not sensitive to random noise in the issue you are monitoring. Also, the T3 modifies the “lag and overshoot” properties of a simple moving average. In other words, the T3 draws a very smooth moving average and has a tendency to be rather sensitive to significant directional changes in the market (mostly, eliminating the “whipsawing” that many traders are familiar with when using simple moving averages). I won’t get into the mathematical complexities of the formula on which the T3 is based here—more important is how it can be applied to your trading.
Chart 1: March Soybeans

THE TREND IS TRULY YOUR FRIEND

If I had to pick a single tool to help traders, it would be an indicator to define trend. The “trend is your friend” is an adage that is overused in technical circles. In fact, the “trend is truly your friend.” Years ago, I decided no matter what time frame that I was trading in, I would only place trades in the direction of the existing trend. Since that epiphany, my trading has improved. Let’s see how the T3 acts as a trend identifier.

Chart 1 shows how well the T3 defines trend. March soybeans have chopped back and forth between $4.98 and $5.65, changing direction every two or three weeks for the last four months. When the T3 has a positive posture (pointing up) we see an abundance of white candles (days when the bulls are in control and the close is higher than the opening). When the T3 has a negative slope, the market has a tendency to produce a majority of black candles. Many of us have heard the adage, “the trend is your friend” and in life, “go with the flow.” These are truly words of wisdom. Trading against the trend can be hazardous to your financial health. Chart 1 tells a simple story: the T3 can define the direction of the market with very little lag. . . don’t trade against that direction.

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Chart 2 displays soybean price history in 2005. I use the T3 not only as a directional indicator (trend identification), but also as an indicator to define support and resistance. Notice how well price was resisted at the down-trending T3 line and how well price was supported at the up-trending T3 adaptive moving average. Many approaches can be developed when one has a reliable indicator. I witnessed traders who day-traded futures contracts and scalped in the direction of the T3. In the morning, they buy the opening (providing the T3 is positive), and in the afternoon they sell their positions market-on-close. In Chart 2, a similar strategy would have profited handsomely.
Chart 3: March Soybeans

Let’s review the concepts I have presented by looking at Chart 4. In early November 2004, April gold futures turned up. The T3 sensed the directional change and adapted quickly to the upside. For the following four weeks of trading, purchasing gold at or near the T3 line would have been very rewarding. As the price of gold painted a roller-coaster pattern on the charts, the T3 consistently pointed to the direction of the trend and provided support and resistance as gold bounced up-down-up-down-up-down.

Chart 2: March Soybeans

Moving averages can be the driving math behind some really interesting momentum oscillators. In Chart 3, I have taken the T3 and then subtracted the same indicator, but set to five days, instead of three. To state it differently, I have subtracted two adaptive moving averages from one another. In this case, I subtracted the five-period moving average: T3(5) from the three-period moving average T3(3). The results are a rather smooth oscillating momentum indicator. I have attached dotted blue and red lines to help discern the indicator directional turns. Of course, each directional turn in the indicator is not known with certainty until the close of the following bar, but it can be of great value. I use momentum oscillators every day. Every issue that I analyze, I examine the current status of the oscillator. Many of my best mechanical systems have moving average oscillators as the featured trigger generator.
T3 CAN HELP YOU FIND THE TREND
Chart 4: April Gold

Markets draw pictures that we interpret through chart analysis. All my chart analysis starts with the identification of the trend. I only trade in the direction of the trend. The T3, an adaptive moving average, can help you discern trend direction. Always trading with the trend will improve most investors’ decisions. Using a moving average as support and resistance is a way to help you improve entry and exit strategies. I use these tools daily and I encourage you to take the time to investigate how they might help you.
Steve Karnish is Principal of Cedar Creek Trading. Learn more about other kinds of moving averages and how they differ, including the T3, and apply the concepts to single-stock futures markets in our archived webinar given February 1, 2005. Go to the Events archive area. Coyyright 2005 CedarCreekTrading.com. All rights reserved. Used with permission by Equis Intl.

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GLOSSARY OF TECHNICAL ANALYSIS TERMS GLOSSARY OF TRADING STRATEGIES TERMS GLOSSARY OF BASIC FUTURES TERMINOLOGY

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Technical Analysis Terms Glossary
Here you can review a short list of the jargon used in reference to the technical analysis and futures. Definitions are not intended to suggest the correct legal significance or exact meaning. They were collected from several sources to help in your understanding of the futures and options industry.
Chaos Theory/Trading

Also called non-linear dynamics, chaos theory involves complex analysis but is essentially a tool to determine whether repetitive patterns and cycles exist in the markets; that is, the presence of an underlying order. It involves the study of historical price action and use of mathematical and statistical tools.
Closing Out

Bb
Bar Chart

Liquidating an existing long or short futures or options position with an equal and opposite transaction. Also called offsetting.
Commitments of Traders Report (COT)

A chart that graphs the high, low, and settlement prices for a specific trading session over a given period of time.
Bollinger Band

A weekly report from the Commodity Futures Trading Commission providing a breakdown of each Tuesday’s open interest for markets in which 20 or more traders hold positions equal to or above the reporting levels established by the CFTC. Open interest is broken down by aggregate commercial, non-commercial, and non-reportable holdings.
Congestion

An indicator used to compare volatility and relative price levels over a specified time period. Three bands are plotted: a simple moving average, an upper band of the simple moving average plus two standard deviations, and a lower band of the simple moving average minus two standard deviations. When the markets become more volatile, the bands widen, or move farther away from the average. When the markets are less volatile, the bands contract, or move closer to the average.

A period of time characterized by repetitious and limited price fluctuations.
Correction

Cc
Candlestick Chart

A temporary reversal in prices following a significant trending period.
Counter-Trend Trading

Candlestick charts provide a quick visual picture of the relationship between opening and closing prices and their relative strengths or weaknesses, especially for extended periods. The body, which looks like a candle, represents the difference between opening and closing prices. Shadows, which look like wicks, represent price action above and below the body.

The method by which a trader takes a position contrary to the current market direction in anticipation of a change in that direction.

Dd
Directional Movement Index (DMI)

Channel

A trend-following indicator used to determine market trends. It has three components—one for upward price movement, one for downward price movement, and a third that measures the difference in these up-and-down market forces to arrive at an index showing the strength of a trend.

The range of prices between support and resistance levels that a market has traded in for a specific time period.
Charting

The use of graphs and charts in the technical analysis of futures markets to plot price movements, volume, open interest or other statistical indicators or price movement.

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Double Bottom

Gap

Chart pattern describing a drop in price, a rebound, and another drop to the same or close to the level of the first drop, then another rebound. The chart typically looks like a “W” in shape, and the two bottom points of the W represent support areas.
Double Top

Price areas on a chart where no trading takes place. Gaps happen often in markets that trade only part of a day because price-moving events and announcements take place during times when markets are closed. Follow-up price action may cover them, or “fill the gap.”

Chart pattern describing a rise in price, a fall, another rise to the same or close to the level of the first rise, then another fall. The chart typically looks like an “M” in shape, with the two top points of the M representing resistance areas.

Hh
Head-and-Shoulders

A chart formation that resembles a human head-and-shoulders and is generally considered to be predictive of a price reversal. A head-and-shoulders top (which is considered predictive of a price decline) consists of a high price, a decline to the support level, a rally to a higher price than the previous high price, a second decline to the support level, and a weaker rally to about the level of the first high price. The reverse (upside down) formation is called a head-and-shoulders bottom (which is predictive of a price rally).

Ee
Elliott Wave Theory

A theory named after Ralph Elliott, who contended that stock market trends move in discernable and predictable patterns reflecting the basic harmony of nature. In technical analysis, it reflects a charting method based on the belief that all prices act as waves, rising and falling rhythmically in a pattern of five up and three down. Waves essentially reflect psychology of the marketplace as it makes its normal rallies and corrections.

Ll
Liquid Market

A market in which selling and buying can be accomplished with

Ff
Fibonacci

minimal effect on price.

Leonardo Fibonacci was a thirteenth-century Italian mathematician who discovered the significance and unique properties of a simple number series, in which each numeral is added to the previous to create the next one in the series: 0,1,2,3,5,8,13, etc. Fibonacci numbers, and more significantly the ratio of those numbers to each other, can be found throughout nature and cycles. Fibonacci ratios are used in technical analysis to predict retracement areas during pullbacks, as well as targets, called “extensions,” for projected price moves.

Mm
Momentum

The relative change in price over a specific time interval. Often equated with speed or velocity and considered in terms of relative strength.
Moving Average

A statistical price analysis method of recognizing different trends. A moving average is calculated by adding the prices for a predetermined number of days and then dividing by the number of days.

Gg
Gann Theory

Moving Average Convergence/Divergence (MACD)

MACD analysis uses three moving averages, often exponential. Two of them are based on the number of price periods used and the third an average of the difference between the two moving averages. The difference between the readings of the two moving averages is usually shown as a histogram, while the average of that difference is shown as a moving average line plotted on top of the histogram. An important part of MACD analysis is how its movements compare with price movements to determine strength or weakness in the market.
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A method of predicting price movements through the relationship of geometric angles in charts depicting time and price. The methodology was created by W.D. Gann, a financial astrologer who was born in 1878 and became one of the most successful traders of his time. Gann techniques can be complex, but are based on price study, time study and pattern study and operate under the premise markets are cyclical in nature.
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Oo
Open Interest

Rr
Rally

The sum of all long or short futures contracts in one delivery month in one market that have been entered into and not yet liquidated by an offsetting transaction or fulfilled by delivery.
Oscillator

An upward movement of prices.
Range

The difference between the high and low price of a commodity during a given trading session, week, month, year, etc.
Relative Strength Index

A term for indicators used to determine overbought and oversold conditions, often useful when a clear trend can’t easily be determined. Oscillators include stochastics, moving average convergence/divergence, relative strength index and momentum.
Overbought

The Relative Strength Index compares periods with up closes with periods that have down closes to produce an index reading reflecting the strength of price changes on a scale of 0 to 100. The index provides overbought or oversold signals, and divergence/convergence with prices is an important part of the analysis.
Resistance

A term used to describe a technical opinion on a market that has risen too steeply and too fast in relation to underlying fundamental factors.
Oversold

A price area where new selling is expected to emerge to dampen a continued rise. Areas of resistance are found above current prices.
Retracement

A term used to describe a technical opinion of a market has declined too steeply and too fast in relation to underlying fundamental factors. A move opposite the direction of the main market trend.
Reversal

Pp
Parabolic Indicator

A change in the direction of prices.

A strategy that uses trailing stops and a reverse method called stop-and-reversal (SAR) to pinpoint entry and exit points. Price action above the SAR would signal a bullish posture, price action below, a bearish posture.
Point-and-Figure Chart

Ss
Squeeze

A market situation in which the lack of supplies tends to force shorts to cover their positions by offsetting at higher prices.

A method of charting that uses prices to form patterns of movement without regard to time. It defines a price trend as a continued movement in one direction until a reversal or predetermined criterion is met. Xs are used to represent upticks, while Os represent downticks.

Stochastics

Stochastics measures the closing price relative to the low of the range for a selected period to indicate rising or falling momentum, providing trading signals when its lines cross into overbought or oversold territory. As an overbought/oversold indicator, the stochastic indicator attempts to forecast turns in market action.
Support

The place on a price chart where it is expected buying of futures contracts will be sufficient to halt a price decline. Areas of support are found beneath current prices.

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Tt
Technical Analysis

An approach to forecasting commodity prices that examines the patterns of price change, rates of change, and changes in volume of trading and open interest, without regard to underlying fundamental market factors.
Trend

The general direction, either up or down, in which prices have been moving.
Trend lines

Lines drawn across successively higher bottoms in uptrending price action or progressively lower tops in downtrending price action. Prices crossing a trend line may indicate a change in direction has occurred.

Vv
Volatility

A measurement of the change in price over a given time.
Volume

The number of purchases and sales of futures contracts or options on futures contracts made during a specified period of time.

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Trading Strategy Terms Glossary
Here you can review a short list of those items you’re most likely to encounter when reading about futures trading strategies. Definitions are not intended to suggest the correct legal significance or exact meaning. They were collected from several sources to help in your understanding of the futures and options industry.
Convergence Call Option

An option that gives the buyer the right, but not the obligation, to purchase (go long) the underlying futures contract at the strike price on or before the expiration date.

The tendency for cash and futures prices to come together (i.e., the

Bb
Bear Spread

basis approaches zero) as the futures contract nears expiration.
Contrarian

Contrarian traders take positions against the prevailing market trend, that is, buy, or go long, when prices are falling and sell, or go short, when prices are rising. A contrarian trader may aim to profit from a series of small trades based on fluctuations within the prevailing trend, or may be anticipating a change in direction based on momentum indicators or other analysis tools.
Counter-Trend

The simultaneous purchase and sale of two futures contracts in the same or related commodities with the intention of profiting from a decline in prices but at the same time limiting the potential loss if this expectation does not materialize. In agricultural products, this is accomplished by selling a nearby delivery and buying a deferred delivery.
Black Box Trading

Against the prevailing trend. The market may make a short-term counter-trend move within a prevailing long-term trend. Countertrend traders aim to take advantage of this tendency by buying when prices are low and selling when prices are high, or they may be anticipating a change in direction based on momentum indicators or other analysis tools.
Covered Call

Black box trading, or automated trading, refers to the use of computerized systems with buy and sell instructions generated by a proprietary software program.
Bull Spread

The simultaneous purchase and sale of two futures contracts in the same or related commodities with the intention of profiting from a rise in prices but at the same time limiting the potential loss if this expectation is wrong. In agricultural commodities, this is accomplished by buying the nearby delivery and selling the deferred. An option spread position where calls are sold against a long position in the underlying instrument. In essence, the trader is limiting his profit on the long position in exchange for receiving the option premium. On option expiration day, the breakeven on the long futures is lower by the amount of option premium received, less commissions.

Cc
Counter-Trend Trading

The method of trading by which a trader takes a position contrary to the current market direction in anticipation of a change in that direction. Cabinet Trade A trade that allows options traders to liquidate deep out-of-themoney options equal to less than one tick.

Covered Option

A short call or put option position which is covered by the sale or purchase of the underlying futures contract or physical commodity. For example, in the case of options on futures contracts, a covered call is a short call position combined with a long futures position. A covered put is a short put position combined with a short futures position. Also called a Covered Write. (See also Covered Call and Covered Put).

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Covered Put

An option spread position where Puts are sold against a short position in the underlying instrument. In essence, the trader is limiting his profit on the short position in exchange for receiving the option premium. On option expiration day, the breakeven on the short futures is raised by the amount of option premium received, less commissions.

Ee
Exercise

The action taken by the holder of a call option if he or she wishes to purchase the underlying futures contract or by the holder of a put option if he or she wishes to sell the underlying futures contract.
Exercise Price

Dd
Day Trade

The price at which the futures contract underlying a call or put option can be purchased (if a call) or sold (if a put). Also referred to as strike price.

The purchase and sale of a futures or an options contract in the same day, thus ending the day with no established position in the market or being flat.
Day Traders

Ff
Fill or Kill

Speculators who take positions in futures or options contracts and liquidate them prior to the close of the same trading day.
Day Trading

A customer order that is a price limit order that must be filled immediately or cancelled.

(See Day Trade)
Day Order

Gg
Gamma

An order that is placed for execution during only one trading session. If the order cannot be executed during that session, it is automatically cancelled.

A measurement of how fast delta changes, given a unit change in the underlying futures price.
Global Macro

Day Trade

A strategy in which trading decisions are based on global economic and political factors, that is, macroeconomic principles.
Good ‘til Canceled (GTC)

The purchase and sale of a futures or options contract during only one trading session. If the order cannot be executed during that session, it is automatically cancelled. A day trader places and liquidates trades during one trading session.
Delta

An order worked by a broker until it can be filled or until canceled (see Open Order).

A measure of how much an option premium changes, given a unit change in the underlying futures price. Delta is often interpreted as the probability the option will be in-the-money by expiration.

Hh
Hedge

Differentials

The purchase or sale of a futures contract as a temporary substitute for a cash market transaction to be made at a later date. Usually it involves opposite positions in the cash market and futures market at the same time.

Price differences between classes, grades, and delivery locations of various supplies of the same commodity.
Discretionary Account

An arrangement by which the holder of the account gives written power of attorney to another person to make trading decisions. Also known as a controlled or managed account.

Horizontal Spread

The purchase of either a call or a put option and the simultaneous sale of the same type of option with typically the same strike price but with a different expiration month. Also referred to as a calendar spread.

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In-the-Money Option

Market Neutral

A trading strategy that aims to profit from both rising and falling prices, often by taking a combination of long and short positions in one or more markets. True market neutrality means the expected beta, or market risk, is equal to zero. Traders who employ a market neutral strategy are attempting to exploit market momentum.
Momentum

An option with intrinsic value. A call option is in-the-money if its strike price is below the current price of the underlying futures contract. A put option is in-the-money if its strike price is above the current price of the underlying futures contract.
Intrinsic Value

The relative change in price over a specific time interval. Often equated with speed or velocity and considered in terms of relative strength. The amount by which an option is in-the-money.
Inverted Market

A futures market in which contracts nearer to expiration are priced higher than those in more distant months. Also called backwardation, an inverted market typically reflects a market facing a supply shortage.

Nn
Naked Option

The sale of a call or put option without holding an equal and opposite position in the underlying instrument. Also referred to as an uncovered option, naked call, or naked put.
NOB Spread (Notes over Bonds)

Ll
Limit Order (LMT)

A futures spread trade involving the buying (selling) of a 10-year U.S. Treasury note futures contract and the selling (buying) of a U.S. Treasury bond futures contract.

An order type that specifies a certain maximum (or minimum) price, beyond which the order (buy or sell) is not to be executed.
Liquid

A characteristic of a security or commodity market with enough units outstanding to allow large transactions without a substantial change in price.
Liquidate

Oo
One Cancels Other (OCO) Order

A pair of orders, typically limit orders, whereby if one order is filled, the other order will automatically be cancelled.
Open Order (or Orders)

Selling (or purchasing) futures contracts of the same delivery month purchased (or sold) during an earlier transaction. Or, making (or taking) delivery of the cash commodity represented by the futures contract.

An order that remains in force until it is canceled or until the futures contracts expire.
Out-of-the-Money

Mm
Market Depth

A term used to describe an option that has no intrinsic value. For example, a call with a strike price of $400 on gold trading at $390 is out-of-the-money $10.
Out-Trades

A dimension of market liquidity that refers to the ability of the market to handle large trading volumes without a significant impact on prices. Traders may study market depth to determine how and when particular orders may impact price action, and to help time the entry and exit of trades. A situation that results when there is some confusion or error on a trade, e.g., over difference in the understanding of a price at which a trade is done, or the number of contracts traded.

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Pp
Position Trader

Speculative Bubble

A rapid, but usually short-lived, run-up in prices caused by excessive buying which is unrelated to any of the basic, underlying factors affecting the supply or demand for the commodity. Speculative bubbles are usually associated with a “bandwagon” effect in which speculators rush to buy the commodity (in the case of futures, “to take positions”) before the price trend ends, and an even greater rush to sell the commodity (unwind positions) when prices reverse.
Straddle

An approach to trading in which the trader either buys or sells contracts and holds them for an extended period of time.
Pyramiding

The use of profits on existing positions as margin to increase the size of the position, normally in successively smaller increments.

Rr
Risk/Reward Ratio

An option position consisting of the purchase or sale of put and call options with the same expiration date and the same strike prices.
Strangle

The relationship between the probability of loss and profit. This ratio is often used as a basis for trade selection or comparison.

An option position consisting of the purchase or sale of put and call options having the same expiration date but different strike prices.
Strong Hands

Ss
Scale Down (or Up)

When used in connection with delivery of commodities on futures contracts, the term usually means that the party receiving the delivery notice probably will take delivery and retain ownership of the commodity; when used in connection with futures positions, the term usually means positions held by trade interests or wellfinanced speculators.

To purchase or sell a scale down means to buy or sell at regular price intervals in a declining market. To buy or sell on scale up means to buy or sell at regular price intervals as the market advances.
Scalp

To trade for small gains. Scalping normally involves establishing and liquidating a position quickly, usually within the same day, hour or even just a few minutes.
Small Traders

Tt
Trading Arcade

A trading facility where independent traders can gather for computerized trading, often operated by a clearing member.

Traders who hold or control positions in futures or options that are below the reporting level specified by the exchange or the CFTC.
Spreading Trailing Stop

A technique often used in attempt to protect profits without limiting potential gains by moving a stop up or down with the market. A stop order would be raised on a long position in a bullish market, and lowered on a short position in a bear market. For example, a trader initiates a long futures position when the market is at $4, and places a protective stop at $3. The market then rallies to $10. He or she then moves the stop up to $9, exiting the position if the market falls to $9. The simultaneous buying and selling of two related markets in the expectation that a profit will be made when the position is offset. Examples include: buying one futures contract and selling another futures contract of the same commodity but different delivery month; buying and selling the same delivery month of the same commodity on different futures exchanges; buying a given delivery month of one futures market and selling the same delivery month of a different, but related, futures market.

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Time Value

The amount option buyers are willing to pay, above the intrinsic value, for an option in the anticipation that, over time, a change in the underlying futures price will cause the option to increase in value. In general, an option premium is the sum of time value and intrinsic value. Any amount by which an option premium exceeds the option’s intrinsic value can be considered time and volatility value. Also referred to as extrinsic value.
Trend-Following

Trend following is a strategy that follows the market’s prevailing direction, buying when prices are rising and selling when prices are falling. This presumes the prevailing trend will continue.

Vv
Vertical Spread Buying and selling puts or calls of the same expiration month but different strike prices.
Volatility Trading

Strategies designed to take advantage of the changes in volatility of the market rather than the direction of the market.

Ww
Weak Hands

When used in connection with delivery of commodities on futures contracts, the term usually means that the party probably does not intend to retain ownership of the commodity; when used in connection with futures positions, the term usually means positions held by small speculators.

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Introductory Futures Terms Glossary
Here you can review a list of the jargon we use in the futures industry. These terms will help you gain a basic understanding of the “language of the futures industry.” Definitions are not intended to suggest the correct legal significance or exact meaning. They were collected from several sources to help in your understanding of the futures and options industry.
Broker

A person paid a fee or commission for executing buy or sell orders for a customer. In commodity futures trading, the term may refer to: (1) Floor Broker - a person who actually executes orders on the trading floor of an exchange; (2) Account Executive or Associated Person - the person who deals with customers in the offices of Futures Commission Merchants; or (3) the Futures Commission Merchant.

Aa
Arbitrage

Bid

The price that the market participants are willing to pay. A motion to buy a futures or options contract at a specified price. Opposite of offer.
Bear

The simultaneous purchase and sale of identical or equivalent financial instruments or commodity futures in order to benefit from a discrepancy in their price relationship.
Ask

One who expects a decline in prices. The opposite of a “Bull.” Remember that a bear attacks by striking his paw downward.
Bear Market

A motion to sell. The same as offer. Indicates a willingness to sell a futures contract at a given price. (See Bid.) A market in which prices are dropping.

Bb
Back Month

Bull

One who expects prices to rise. The opposite of “Bear.” Remember that a bull attacks by thrusting his horns upward.
Bull Market

Futures delivery months other than the spot or front month. (Also called deferred months.)
Basis

A market in which prices are rising. The difference between the current cash price and the futures price of the same commodity. The basis is determined by the costs of actually holding the commodity versus contracting to buy it for a later delivery (i.e. a futures contract). The basis is affected by other influences as well, such as unusual situations in supply or demand. Unless otherwise specified, the price of the nearby futures contract month is generally used to calculate the basis. (See Carrying Charge.)
Carrying Charge (Cost of Carry)

Cc
For physical commodities such as grains and metals, the cost of storage space, insurance, and finance charges incurred by holding a physical commodity. In interest rate futures markets, it refers to the differential between the yield on a cash instrument and the cost necessary to buy the instrument. (See Basis.)
Cash Commodity

An actual physical commodity someone is buying or selling, e.g., soybeans, corn, gold, silver, Treasury bonds, etc. Also referred to as Actuals.

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Cash Market

Day Trading

A place where people buy and sell the actual commodities, i.e., grain elevator, bank, etc. (See Spot and Forward Contract.)

(See Day Trade.)
Deferred Month (AKA: Back Months)

Cash Price

The more distant month(s) in which futures trading is taking place, as distinguished from the nearby (delivery) month.
Deliverable Grades (AKA: Contract Grades)

The price of the actual physical commodity that a futures contract is based upon.
Commodity

The standard grades of commodities or instruments listed in the rules of the exchanges that must be met when delivering cash commodities against futures contracts. Grades are often accompanied by a schedule of discounts and premiums allowable for delivery of commodities of lesser or greater quality than the standard called for by the exchange.
Delivery

An article of commerce or a product that can be used for commerce. In a narrow sense, products traded on an authorized commodity exchange. The types of commodities include agricultural products, metals, petroleum, foreign currencies, and financial instruments and indexes, to name a few.
Contract

Unit of trading for a financial or commodity future. Also, actual bilateral agreement between the parties (buyer and seller) of a futures or options on futures transaction as defined by a futures exchange.

The transfer of the cash commodity from the seller of a futures contract to the buyer of a futures contract. Each futures exchange has specific procedures for delivery of a cash commodity. Some futures contracts, such as stock index contracts, are cash settled.

Dd
Daily Trading Limit

Delivery Month

A specific month in which delivery may take place under the terms of a futures contract. Also referred to as contract month or front month.
Delivery Points

The maximum price range set by the exchange each day for a contract. A trading limit does not halt trading, but rather, limits how far the price can move in a given day.
Day Order

The locations and facilities designated by a futures exchange where stocks of a commodity may be delivered in fulfillment of a futures contract, under procedures established by the exchange. An order that is placed for execution during only one trading session. If the order cannot be executed (filled) that day, it automatically expires at the close of the trading session.
Day Trade

Ee
Exchange

The purchase and sale of a futures or an options contract in the same day, thus ending the day with no established position in the market or being flat.
Day Traders

(See Futures Exchange.)

Speculators who take positions in futures or options contracts and liquidate them prior to the close of the same trading day.

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Ff
First Notice Day

Gg
Good till Canceled (GTC)

The first day on which a notice of intent to deliver a commodity in fulfillment of a given month’s futures contract can be made by the clearinghouse to a buyer. The clearinghouse also informs the seller who they have been matched up with.
Forward (Cash) Contract

An order worked by a broker until it can be filled or until canceled. (See Open Order.)

Hh
Hedge

A cash contract in which a seller agrees to deliver a specific cash commodity to a buyer sometime in the future. Forward contracts, in contrast to futures contracts, are privately negotiated and are not standardized.
Front Month

The purchase or sale of a futures contract as a temporary substitute for a cash market transaction to be made at a later date. Usually it involves opposite positions in the cash market and futures market at the same time.

(See Delivery Month.)
Futures

Hedger

An individual or company owning or planning to own a cash commodity corn, soybeans, wheat, U.S. Treasury bonds, notes, bills, etc. and concerned that the cost of the commodity may change before either buying or selling it in the cash market. A hedger achieves protection against changing cash prices by purchasing (selling) futures contracts of the same or similar commodity and
Futures Commission Merchant

A term used to designate all contracts covering the purchase and sale of financial instruments or physical commodities for future delivery on a commodity futures exchange.

later offsetting that position by selling (purchasing) futures contracts of the same quantity and type as the initial transaction.
Hedging

A firm or person engaged in soliciting or accepting and handling orders for the purchase or sale of futures contracts, subject to the rules of a futures exchange and, who, in connection with solicitation or acceptance of orders, accepts any money or securities to margin any resulting trades or contracts. The FCM must be licensed by the CFTC.
Futures Contract

The practice of offsetting the price risk inherent in any cash market position by taking an equal but opposite position in the futures market. Hedgers use the futures markets to protect their busnesses from adverse price changes.

A legally binding agreement, made on a futures exchange, to buy or sell a commodity or financial instrument sometime in the future. Futures contracts are standardized according to the quality, quantity, and delivery time and location.
Futures Exchange

Ii
Initial Margin

The minimum value on deposit in your account to establish a new futures or options position, or to add to an existing position. Initial margin amount levels differ by contract. Lind-Waldock sets the level of Initial Margin required, and it may change at any time at Lind-Waldock’s discretion. Increases or decreases in Initial Margin levels reflect anticipated or actual changes in market volatility. Also called “Initial Performance Bond.” A central marketplace with established rules and regulations where buyers and sellers meet to trade futures and options on futures contracts.

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Ll
Last Trading Day

Mm
Maintenance Margin

The final day when trading may occur in a given futures or options contract month. Futures contracts outstanding at the end of the last trading day must be settled by delivery of the underlying commodity or securities or by agreement for monetary settlement (in some cases by EFPs).
Limit Move

The minimum value that you must keep in your account in order to continue to hold a position. The maintenance margin is typically less than the initial margin, and also differs by contract. If your account falls below the maintenance margin requirement, you will receive a margin call. If you wish to continue to hold the position, you will be required to restore your account to the full initial margin level (not to the maintenance margin level). Also known as the Maintenance Performance Bond.
Managed Futures

(See Daily Trading Limit.)
Limit Order

An order given for an options or futures trade specifying a certain maximum (or minimum) price, beyond which the order (buy or sell) is not to be executed.
Leverage

Represents an asset class comprised of professional money managers known as commodity trading advisors (CTAs) who manage client assets on a discretionary basis, using global futures markets as an investment medium.

The ability to control large dollar amounts of a commodity with a comparatively small amount of capital.
Limit Order

Margin

(See Performance Bond.)
Margin Call

(See Price Limit Order.)
Liquid

A demand from a clearinghouse to a clearing member, or from a brokerage firm to a customer, to bring margin deposits up to a minimum level required to support the positions held. This can be done by either depositing more funds or offsetting some or all of the positions held.
Mark-To-Market (Marked-To-Market)

A characteristic of a security or commodity market with enough units outstanding to allow large transactions without a substantial change in price. Institutional investors are inclined to seek out liquid investments so that their trading activity will not influence the market price.
Liquidation

A daily accounting entry that is the bedrock of regulated futures bookkeeping. It’s the end-of-day adjustment made to trading accounts to reflect profits and losses on existing positions. In other words, winnings are credited and immediately available to the account and losses are debited and immediately owed. This brings integrity to the marketplace because participants are not allowed to trade unless funds are available to cover the positions.
Market Order (MKT)

Any transaction that offsets or closes out a long or short futures position.
Long

(1) One who has bought a futures contract to establish a market position; (2) a market position that obligates the holder to take delivery; (3) one who owns an inventory of commodities. See Short.
Long Hedge

An order to buy or sell a specified commodity, including quantity and delivery month at the best possible prices available, as soon as possible.
Market-If-Touched (MIT) Order

The purchase of a futures contract in anticipation of an actual purchase in the cash market. Used by processors or exporters as protection against an advance in the cash price. A price order that automatically becomes a market order if the price is reached.

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Market on Close (MOC)

Pit

An order to buy or sell at the end of the trading session at a price within the closing range of prices.

A specially constructed arena on the trading floor of some exchanges where trading in a futures contract is conducted. On some exchanges the term “ring” designates the trading area for a commodity.
Position

Oo
Offer

A market commitment. A buyer of an initial futures contract is said to have a long position and, conversely, a seller of an initial futures contract is said to have a short position.
Price Discovery

Indicates a willingness to sell a futures contract at a given price. Also called “Ask” (See Bid).
Offset

Taking a second futures or options position opposite to the initial or opening position. This means selling, if one has bought, or buying, if one has sold, a futures or option on a futures contract.
Open Order

The generation of information about “future’’ cash market prices through the futures markets. It has been said that futures markets are often the place of “original price discovery” because that’s where the buyers and sellers are brought together to determine the price. As in any auction, the last price is considered to reflect the sum total of opinions about what price an item should be valued.
Price Limit Order

An order to a broker that is good until it is canceled or executed. (See GTC.)
Open Outcry

An order that specifies the highest price at which a bidder will pay for a contract, or the lowest price a seller will sell a contract. This type of order is used to “limit” how much the trader is willing to “give in” on price to get the order filled.

Method of public auction for making verbal bids and offers in the trading pits or rings of futures exchanges.
Or Better Order (OB)

A type of a limit order in which the market is at or better than the limit specified. The term is often used to help clarify that the order was not mistakenly given as a Limit when it looks like it should be a Stop Order.

Ss
Settlement Price

The last price paid for a commodity on any trading day. The ex-

Pp
Performance Bond (Margin)

change clearinghouse determines a firm’s net gains or losses, margin requirements, and the next day’s price limits, based on each futures and options contract settlement price. If there is a closing range of prices, the settlement price is determined by averaging those prices. Also referred to as Settle or Closing Price. Thinly traded options may be traded at a theoretical value.
Scalp

Funds that must be deposited as a performance bond by a customer with his or her broker, by a broker with a clearing member, or by a clearing member, with the clearinghouse. The performance bond helps to ensure the financial integrity of brokers, clearing members and the exchange as a whole.

To trade for small gains. Scalping normally involves establishing and liquidating a position quickly, usually within the same day, hour or even just a few minutes.

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Short

Stop Limit

(1) The selling side of an open futures contract; (2) a trader whose net position in the futures market shows an excess of open sales over open purchases. (See Long).
Short Hedge

A variation of a stop order. A stop limit order to buy becomes a limit order at the stop price when the futures contract trades (or is bid) at or above the stop price. A stop order to sell becomes a limit order at the stop price when the futures contract trades (or is offered) at or below the stop price.
Tick

The sale of a futures contract in anticipation of a later cash market sale. Used to eliminate or lessen the possible decline in value of ownership of an approximately equal amount of the cash financial instrument or physical commodity.
Speculator

Smallest increment of price movement possible in trading a given contract.

One who attempts to anticipate price changes and, through buying and selling futures contracts, aims to make profits. A speculator does not use the futures market in connection with the production, processing, marketing or handling of a product.
Spot

Market of immediate delivery of and payment for the product.
Spread

The price difference between two related markets or commodities.
Spreading

The simultaneous buying and selling of two related markets in the expectation that a profit will be made when the position is offset. Examples include: buying one futures contract and selling another futures contract of the same commodity but different delivery month; buying and selling the same delivery month of the same commodity on different futures exchanges; buying a given delivery month of one futures market and selling the same delivery month of a different, but related, futures market.
Stop Order

Sometimes called a Stop Loss Order, although it can be used to initiate a new position as well as offset an existing position. It’s an order to buy or sell when the market reaches a specified point. A stop order to buy becomes a market order when the futures contract trades (or is bid) at or above the stop price. A stop order to sell becomes a market order when the futures contract trades (or is offered) at or below the stop price. An order to buy or sell at the market when and if a specified price is reached.

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