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All About Futures: The Easy Way to Get Started, 2nd Edition [Secure eReader]
eBook by Russell Wasendorf

eBook Category: Business
eBook Description: Since 1992's first edition of this bestselling book, the futures market has changed incredibly--Internet access and electronic trading dominate the market, options have grown in importance, and a greater number of futures markets exist worldwide. All About Futures, Second Edition, covers all the updated basics of futures trading for the beginner, and illustrates trading strategies from the simple to the complex for experienced traders who need to brush up on their skills. An integral element in McGraw-Hill's All About series, this completely revised and updated book discusses detailed Internet strategies for effective electronic trading, basic approaches to technical analysis and anticipating price direction, and insights on working with a broker and developing a trading strategy.

eBook Publisher: McGraw-Hill Companies/McGraw-Hill, Published: 2002
Fictionwise Release Date: September 2002


The Nature of the Futures Market

Philosophers throughout the centuries have said that if God didn't exist, man would have invented Him. The creation of futures markets may have been just about as inevitable a concept. Human beings have always had a love-hate relationship with the future: They can't wait for things to get better, and they fear what will happen tomorrow.

On a more mundane level, businesspeople have at least as much difficulty dealing with the unknown as the average person. How can they set firm prices for the products they sell or manufacture if they don't know what they'll have to pay for the raw materials they use? This question is at least 6,000 years old, dating back to when a futures market in rice is thought to have developed in China. By the Middle Ages there was already a sophisticated futures purchasing system for wheat and wool.

A futures market solves the basic business problem of the need to control as much of the future as possible. For example, if you are an importer or processor of crude oil, could you have dealt with the uncontrollable pricing that took place following the 1990 invasion of Kuwait by Iraq -- without the futures markets? If you are a seller of capital equipment to the Japanese and are to be paid in yen 120 to 180 days from now, would you want to hedge the risk of the changing currency values of your payment? What's one of the most efficient methods for farmers to handle the price fluctuations they face each year while their crops are still in the ground?

The futures markets permit users of commodities -- e.g., grains, meats, metals, financials, food, fiber, etc. -- to set a price for their future requirements well in advance of when the commodities are needed. Notice that today's definition of commodities stretches well beyond the physicals and includes security market futures, currencies, interest rates, and more. Producers can likewise lock in acceptable price levels (or profit levels) before their product is ready to be sold.

However, if the futures markets were restricted to bona fide hedgers (producers or users of the commodities) only, the volume of many contracts and some entire markets would be so low that on some days they would not be able to trade. Volume is an essential key to discovering price; it is one of the most fundamental functions of all types of exchanges. The higher the volume is at any given time for a given commodity, the higher the reliability that its price reflects the current supply-demand situation. This is where speculators fit in. Speculators create liquidity in the market. They buy and sell thousands of contracts in hundreds of markets, allowing hedgers to easily transfer risk.

Confidence in understanding where the price of a commodity should be going -- commonly referred to as the trend -- inspires trading, thereby increasing volume. Additionally, high-volume markets are safer to trade. When you place an order for a trade, you have a better chance for it to be filled when trading volume is high. Therefore, the market function of the speculator is to create volume, so that anyone who wants to trade has a market. The speculator's personal objective, naturally, is to make money from the ever-changing ebb and flow of prices.

Who should be a speculator is a much more important question. The term speculate means to engage in risky business transactions on the chance of generating great profits. There are three key terms: risky business, chance, and great profits.

Risky business distinguishes futures speculation from gambling. Gambling generally involves sport and pure chance. Futures speculation is more intellectual, involves research, strategies, and planning.

Detractors of futures trading have always tied their arguments to the second key term, chance. There is always the element of chance when you attempt to forecast what is expected to happen at some time in the future. This is true for commercial real estate investors, insurance companies, bank officers who set interest rates, and even individuals who buy homes. The speed at which the futures markets fluctuates is what makes its detractors wrongly classify it as a game of chance.

The last key term, great profits, is what attracts aggressive investors to this form of investing. A goodly percentage of individual speculators wish to make a lot of money fast. They are greedy. This may be the single most important reason that most small traders lose. Success in the futures markets requires the patience to wait for high-quality trades, to manage money judiciously, to study the markets and do the research required, to control emotional responses to fast-moving opportunities when they are moving for or against your positions, and to have a clear head when everyone around you is losing theirs.

There are rules to follow in the market that are designed to protect you against catastrophic losses, but you can't teach someone to trade successfully. "Natural traders" are as rare as "natural shooters."

The purpose of this book is to teach you enough about the futures markets and its rules so you can protect yourself. However, this knowledge is not a guarantee that you won't get wiped out. The market has a will of its own. Never forget that! If it moves violently against your position, you'll get burned.

The futures market is a zero-based market. At the end of each day, the books are balanced. For every buyer, there is seller. For every seller, a buyer. That means one side wins and one side loses -- every day. And every day, the losers must pay the winners in the form of margin money or reduced equity in their trading account.

Some days you'll win. More often you'll lose. Your objective is to be a net winner in terms of dollars invested. The risk may be heavy, but the possibility of reaping very large profits over very short periods of time attracts the aggressive investor.

Futures trading is not for everyone, but careful study will give you an excellent overview of futures and options on futures. This will help you decide if futures trading will assist you to reach your financial goals; and if so, how you go about entering the markets, what alternative approaches are available to you, and how you can develop strategies to reduce or control risk.

Copyright © 2001 by The McGraw-Hill Companies

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