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INVESTMENT EDUCATION
Exclusively for our Members
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BENEFITS AND
RISKS OF FUTURES TRADING
(Tuesday June 16, 2009)
Of all the financial markets,
perhaps the futures markets have the worse reputation for causing
investors to lose money. While that
reputation is well deserved, the reasons for it are not generally
clearly expressed. Investors are
generally led to believe that the volatility in the markets is cause
for concern. Perhaps
that’s true at some times and in some markets, but in general,
volatility represents an opportunity to make money. Furthermore, not all of the futures
markets are extremely volatile.
Consider the above chart.
It represents the chart for trading a July 2009 cocoa futures
contract. While it is true that
there have been small daily fluctuations in the cocoa market during the
period from January 2009 up to June 2009, it seems clear that for the
most part, cocoa futures represented several clear opportunities to
trade and profit. From around
January 19, 2009 up until February 3, 2009, cocoa futures rose
consistently. Then, from
February 3, 2009 until sometime around March 2, 2009, the cocoa market
fell. This chart reveals three
other such trends, a rising trend between March 9, 2009 and April 6 and
another falling trend between April 6th and April 20th
followed by yet another rising trend from May 18th until
June 11th. You can
see a similar trend in the September Swiss Franc (chart below) from
April 2009 until the last week in May.
Anyone who looks around the futures markets will find such
trends throughout the futures markets, some more opportune (or more
risky) than others.
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Despite obvious daily fluctuations
in the market, each of these trends represented opportunities to make
money. Yes, there was at least
one dangerous period from April 20th until May 18th
when the market was flat, but even during that period, there was a
brief period when cocoa moved from 2300 to 2500 and then back from 2500
to 2300, both representing significant trading opportunities. Each of these two movements
represents movements of 200 points.
In cocoa that is $2,000.00 in two weeks or $4,000 between the
two movements in a month. In
other words, for the patient investor, there have been many
opportunities to benefit from investing in the cocoa market over the
past six months. The reason
cocoa might be of interest to some investors is because it is rather
inexpensive to trade. An at the
money or just in or out of the money cocoa option can cost between $50
and a few hundred dollars as opposed to a few hundred to $2,500 as is
true for some options. A chart
of virtually any stock would hardly reveal any more lucrative financial
opportunity during the past six months.
Furthermore, most investors in stocks desire the market to go up
and shun declining markets, so they desire the market to either go up
or remain stable. When trading
options, it doesn’t matter whether the market is going up or
down. It only matters that the
trader is on the right side of the market move. For example, in the stock market
crash of 1987, while many investors lost money, many others made a ton
of money by using options (puts) that made money when the market
declined.
The fact is that most investors do
not realize that an investor can make money when the market goes up or
down and do not know how to make money in a declining market without
taking undue risks by shorting the market (selling to open a trade and
buying back to close the same trade.
Most investors go long, that is buying to open a trade and
selling to close the same trade).
One means of making money in a declining stock market is by
using stock options, but options (both stock options and futures
options) also decrease the
risk from trading in the volatile futures markets and allow traders to profit no matter what direction the
market moves as long as the trader is on the right side of the market
movement. Thus, a speculator
(that’s what futures traders are called) could have used futures
options to take advantage of the all of the movements of cocoa futures
from January 2009 up to the present.
In fact, if you were to look at virtually any futures trade, you
would probably have seen
similar trading opportunities in about half the commonly traded futures
contracts such as unleaded gasoline, petroleum, heating oil, soybeans,
corn, wheat, precious metals and more.
Why, then, is the futures market viewed as being risky?
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Although the futures markets often
provide opportunities to make money, most speculators trade commodities
as if they were gambling in Las Vegas or
Atlantic City. One of the first rules of trading
actually has nothing to do with the trade you make, but rather involves
having a trading strategy and plan and following that plan. In scuba diving, the rule is to plan
your dive and dive your plan. A
similar practice is necessary in trading futures.
The reason I have considered the
cocoa market is because it is a relatively inexpensive market to
trade. It is possible to trade
cocoa with only a couple of hundred dollars and to increase that (or
lose it) several fold in a week to a couple of weeks. By contrast, precious metals are
expensive as are crude oil, unleaded and other futures contracts. The most reasonable options contracts
in the futures markets are corn, soybeans and wheat as well are sugar
and a few others, but even currencies and bonds can represent lucrative
opportunities for financial gain if traded wisely and as if you are
investing rather than as if you are in a casino in Las Vegas. The July cocoa chart above clearly
demonstrates that there are real opportunities in trading at least some
futures contracts. What are the
risks? Well, first and foremost,
no one knows what the market will do before the market does it, but that is always true in any
market! Then, of course, the
National Futures Association (NFA) wants traders to be aware that
options expire. If you
don’t make a profit before expiration, you can lose all of the
money you invested. The actual
question speculators need to ask is “Are the benefits worth the
risks?” In some situations
the answer is clearly, “Yes” while in other situations the
answer is clearly “No”.
Therefore, each investor must weigh the benefits and the risks
associated with every individual
trade and decide for him/herself. That is what we want to help you do
here by educating you.
WHY INCLUDE
INVESTING ON THIS SITE?
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When I changed the design of this site, I asked a friend to look at the
old site and make suggestions for changes. One suggestion he made was
not to include our focus on investing on the opening web page of the
site. I didn't really like the idea, but considering the effect the
investing information had on him, I had to give serious consideration
to his comment. It's certainly obvious that investing, per se, has
little or nothing to do with sex and the soul, but sex and the soul are
related to investing. That, however, has no bearing on why investing
education has been included on this web site. To be honest, they have
been included because I am as intimately familiar with investment and
finance as I am with neurochemistry and the soul. So, I decided to
offer people the opportunity to learn more about investing than most
people know, including many astute investors.
Most astute
investors are familiar with one type of investments. That will usually
be stocks, bonds or futures. Some of the most sophisticated may also be
familiar with options. Most investors aren't really intimately familiar
with any of these. They know the basics--buy stocks low and sell
high--and some are familiar with the companies they buy and what to
look for. But few are really familiar with investing beyond buying low,
selling high and knowing something about the company. I think the
latter point, knowing about the company, is useless for investors in
most situations. But, since most investors view themselves as being
long term investors planning for the future, it is useful at some
point.
Let's face it. No
matter how long you intend to invest in a company, your main reason for
investing is to make money. If you intend to do that, you need to make
some ground rules for your investing, and follow them. Long term
investing and knowing about the company you're buying are just part of
what needs to be known, and only a small part at that.
Since I have as
extensive background in investment and finance as I have in
biochemistry and neuroscience, I decided it would be nice to offer this
knowledge to any interested members of the web site. My reason for
including investment education on the site was as simple as that. I am
no longer in the stock industry or the futures industry, but I actively
trade stocks, bonds, futures, currencies and options on stocks, futures
and currencies. I see no reason not to pass this information on to
others along with my knowledge of health, medicine and the soul!
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One of the very first ideas I wish to pass on to members of the web
site is to do as scuba divers do. In scuba diving, we are told to plan
your dive and dive your plan. That is, to plan every major aspect of
the dive before diving, and then to follow the plan you have outlined.
Investing is exactly the same. You must determine your financial goals,
map a strategy for achieving those goals, and then follow the plan you
have mapped, modifying it as necessary as you go along.
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The futures markets are one of the most risky areas of investing.
Although I've never seen the statistics, it is said that 90% of those
who trade the futures markets lose money. Since futures are a zero sum
endeavor (i.e., for every winner, there is a loser), the fact that 90%
of those who trade futures end up as losers means that the 10% who make
money are making a lot of money! Indeed, I have worked for futures
firms where it was difficult to find a profitable account 3 to 6 months
after the account was opened! I have looked at this situation in depth,
and reached the conclusion that there is a reason for this situation.
Most people in the futures markets trade futures as if they are at a
slot machine for roulette table in Las Vegas. So, let me make some
suggestions that will help make money in the futures markets as well as
in currencies, stocks and bonds. These are not trading rules (which I
have and will discuss in the future), but guidelines for anyone engaged
in the financial markets. These guidelines apply BEFORE TRADING STARTS,
while trading and after trades are completed!
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We think we can offer you and new, refreshing and unique view on investing.
It is not our intention to give investment information, but rather, to
provide educational information that will improve your knowledge of
investing and give you new ideas regarding your approach to investing.
Educating people about investing can mean anything from teaching people
different investment strategies to merely warning about the pitfalls
and dangers of working with a brokerage firm. In this day and age when
many people are investing on their own, it's imperative that they know
the benefits and pitfalls in what they are doing. We provide this
information just because we can. We think you can benefit a lot. If
you're lucky, perhaps you can make enough money from this education to
pay for the site for years to come. But, If we can just increase the
value of your investment portfolio a little, we feel the effort will
have been worth it.
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