924 Trading 101 | Midwest Futures - Commodity Futures Brokerage
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Trading 101

Getting Started

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How to Start Trading

Getting started trading commodity futures and options with Midwest Futures can be relatively simple. Once we have designated the right commodity futures broker for you, you can open a commodity futures trading account. To do this you must sign a variety of documents, which are provided for your financial security. (Be sure to read them carefully and ask questions if there is something you do not understand.) Then, you must deposit a performance bond, known as a margin deposit or a good faith deposit, generally in the form of cash or certain securities. For information on getting started in commodity futures and options trading, contact one of our licensed commodity futures brokers or call us toll free at (800) 672-8303.

Tracking your Trades

“What's the current price?” is the first and most important question you must answer when you're trading commodity futures and options. Price information is available from:

  • Brokers
  • Quote vendors
  • Major daily and weekly newspapers
  • On-line computer information services
  • Private advisory services
  • Financial programs on television and radio

It is also vital to know that when trading Managed Futures, the current prices are available to you from your Commodity Trading Advisor (CTA).

Trading Styles

Trading decisions typically are based on the opinion that a market's fundamental or technical outlook is going to change. Fundamentals include the market's supply and demand forces; technicals encompass a wide range of charting techniques involving a market's price, cycles or volatility.

Fundamentals

Fundamentals can be summed up in two words – supply and demand. The first traders to know or anticipate the changes in supply and demand have the edge.

Technicals

Many traders make decisions based on technical indicators. Chart price patterns, cycles, momentum indicators, volume, open interest and mathematical calculations are some of the technical indicators used by technical traders.

The most common starting point for technical analysis is the bar chart, which plots a trading period's opening, high, low and closing prices. Traders watch for new highs and lows, broken trend lines and other patterns that are used as entry and exit points.

Many people prefer to use charts to trade because the price includes all fundamentals and technicals known to the commodity futures market.

The Trading Process

Trading decisions typically are based on the opinion that a commodity's fundamental or technical outlook is going to change. But thinking one knows what the futures market is going to do is the single most destructive way to trade. You may believe something and you may be right but it does not mean you will be right the next time.

Always be prepared to get out when the prior hits a preset area. Don't think you know more than the market.

Executing an Order

Once you've made your trading decision, you would then contact your commodity futures broker. After you give the broker the buy or sell order, it is transmitted directly to the trading floor via telephone or data transmission lines. Upon receipt, the order is time-stamped and delivered to the trading area, or pit, by an order clerk or runner. The trading pits are each divided into a number of sections designated for trading in particular contract months. No trading may occur outside a contract's assigned pit, nor is trading permitted at any time other that during those hours which have been designated by the Exchange.

Concepts to Know

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Floor Broker Responsibilities

An individual floor broker is responsible for executing your order. Floor brokers are licensed by the federal government to execute trades for the public.

Price Limits

Most commodity futures markets have daily price limits; which mean that prices can move only a certain amount in any trading day. These limits are determined by the Exchange Clearing House (with Commodity Futures Trading Commission (CFTC) approval) on the basis of variations experienced in the underlying cash markets, and are adjusted from time to time as price volatility changes. In some commodities, the contract month trades without limits for a short period before its expiration. Price limits also allow time for collecting margin calls.

Contracts Traded

Whenever a commodity is actively bought and sold in the cash market and there are enough people who could benefit from having a futures contract for that commodity, an exchange can decide to introduce a new futures contract for that product.

There are many commodities that have contracts on them. There are meats such as hog, cattle, feeder cattle and pork bellies. There are grains such as corn, soybeans, wheat, oats, barley and canola. Maybe you want to trade in the currencies, which include contracts on yens, francs, dollars, euros and many more. Also you may want to try your hand in the Softs, which includes such commodities as sugar, cocoa, coffee and cotton. The list goes on and on.

Regulation Authorities

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There are three regulation authorities.

  1. The Commodity Futures Trading Commission (CFTC)
  2. The National Futures Association (NFA)
  3. The commodity exchanges

The CFTC is the independent federal regulatory agency that oversees the US futures markets and exchanges.

The NFA is a CFTC authorized organization that handles the registration and licensing of all the industry participants who are exchange members. These members are anyone who as brokerage firm employees, have contact with the public or someone that manages a trading account for a public customer.

The commodity exchanges set margin requirements as well as establishing contract specifications.

Supply and Demand

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The price of agricultural commodities fluctuate, foreign exchange rates change from minute to minute, and interest rates and equity indexes rise and fall. Nothing stays the same. That is why a clear understanding of supply and demand is necessary when trading commodity futures.

Supply (How Much Product?)

Supply is defined as the quantity of a product that sellers are willing to provide to the market at a given price. When prices are high, sellers are willing to provide larger amounts of their products to the market. It's human nature. When prices are low, sellers are willing to provide smaller amounts to the market. This relationship between product supply and its price is called the law of supply.

Many economic factors can cause supply to increase or decrease, and that causes the supply curve to shift. But let's talk real life. When cattle prices are low, there's not much incentive for cattle producers to provide cattle to the market. If cattle prices rise, so does the incentive to provide more cattle. Other things can happen to affect supply. The price of feed may be low, encouraging more cattle production, or too high, causing producers to cut back on production. Each commodity has its own supply factors – even currency, interest rate and equity stock index products. But supply is only half the story.

Demand (How much need is there?)

Demand is defined as the quantity of a product that buyers are willing to purchase from the market at a given price. When prices are high, buyers are willing to buy less of the product. When prices are low, buyers are willing to buy greater quantities of the product. This relationship between product demand and its price is called the law of demand.

Many economic factors can cause demand for a product to increase or decrease, causing the demand curve to shift. You can imagine how the demand for beef can change depending on its supermarket price or how people feel about eating beef. And it's fairly easy to see how economic conditions could change the demand for credit or the demand for a foreign currency. Each commodity has its own demand factors.

The Market Price (Reality or the Perception of Reality?)

The price of a product or a commodity depends on the relationship between supply and demand. As a whole, prices will go up when demand exceeds supply and prices will go down when supply exceeds demand.

Fundamental Analysis (Trying to find the truth)

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Fundamental analysis is the study of the factors that affect supply and demand. The key to fundamental analysis is to gather and interpret this information and then to act before this information is incorporated into the futures price. This lag time between an event and its resulting market response presents a trading opportunity for the fundamentalist.

Agricultural Analysis

For livestock, the fundamental trader studies both supply and demand. The U.S. Department of Agriculture releases several monthly and quarterly reports that supply statistics. Inflation, consumer tastes, consumption patterns and population numbers all affect the demand for meat. The fundamental trader puts all these factors into sophisticated models to try to determine where livestock prices are going.

Financial Analysis

As you would expect, trading financial futures calls for a study of entirely different supply and demand factors. The overall health of the economy is a key factor to watch. Economic reports such as the Leading Indicator Index, Consumer Price Index, Gross National Product and the Employment Situation are only a few of the reports providing information.

For example, changes in the economy's direction normally signals major interest rate turning points. This is obviously important to anyone trading interest rate futures such as U.S. Treasury bills. The demand for money rises during economic expansion, causing interest rates to rise. Likewise, the demand for money falls during economic recession, causing interest rates to fall. The fundamentalist can also study the relationship of long-term and short-term interest rates to predict the direction of interest rate movement.

Technical Analysis (Reacting before the news.)

This approach to price prediction is based on the premise that price movements follow consistent historical patterns. Those who engage in technical analysis study charts or statistics that measure price movements and try to find repetitive patterns. They start with the basic bars chart that plots high, low and closing prices of a futures contract over the life of the contract. Current activity is watched carefully for familiar patterns of price movement.

The uptrend, downtrend and sideways trend patterns experienced in the past can alert a chartist to such a movement forming in the current market.

The chartist also watches daily volume numbers (the number of contracts traded each day) and open interest numbers (the number of contracts not yet offset). These numbers are used to assess the strength of a trend.

What patterns does a chartist look for? (Price is all that matters.)

As the days during the life of a futures contract pass, the chartist watches for price reversal patterns and price continuation patterns. That is, if prices are headed up, are they going to reverse themselves and head down? If prices are headed down, are they going to start moving up? Or will prices keep heading in the same direction? There are many technical patterns that are used to trade off of. Be consistent on which ones you use. Don't jump from one to another or you will not have the discipline to stay with a trade. You will always be able to find a reason to get out if you use too many indicators.

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