Why Buy Gold and When to Sell Gold

 Why buy gold and when to sell gold is not as difficult as it seems.

On the-privateer.com it states, " In any discussion of the future of Gold, or of the price of Gold, the first thing that must be realized is that Gold is a political metal. In the true meaning of the word, its price is "governed".

"This is so for the very simple reason that Gold in its historical role as a currency is fundamentally incompatible with the modern worldwide financial system."

Throughout history, up to August the 15th 1971, in fact, there has always been a link between paper money and gold. The history of money is littered with the connections. Either gold itself was used as a currency, or if paper was used it was backed by or represented a value of gold.

Since that fateful day in August 1971 however, the successful action of having a medium of exchange was dropped and paper itself was called upon to represent value. But paper currencies hinge on the concept that the debt on which they are based will be repaid. The only way this is being done currently is with more paper money.

Richard Russell, editor and publisher of the Dow Theory letters commented in a recent post on his website:

"Quotes are great if you own stock in a public company in a big bull market. But the great majority of amateur investors make more money holding their homes over the years than they ever make in the stock market. And the reason is that if they own a home over the years, and that home is sensibly financed, they aren’t scared out their home by those damnable quotes during bear markets.

Holders of gold might mull over the same concept. Sure gold is quoted every hour of the day around the world. Long-term holders of gold might do well to ignore the quotes. If gold doubles in price, so what? -- are you going to swap your gold for paper? If gold drops by a third, so what? – are you going to dump your gold for paper?

Why not just relax and hold your gold? Hold your gold – why? The reason is that gold is the only true money, it's the only money that remains wealth no matter what happens in the world. Gold is wealth during the biggest boom and gold remains wealth during the worst depression. So why dwell on the daily dollar price, even though gold is quoted everywhere every hour of the day? Forget the bloody quotes, just accumulate gold. It's a good thing to have in today's unstable world."

So in short, that answers the question, why buy gold and when to sell gold.

How to Buy Gold and Silver on the Comex

This article is about how to buy gold and silver on the Comex. Firstly, for those unfamiliar with the Comex, it gives a brief overview of how it works and how futures contracts for gold and silver work. Then there is some information that an investor might want to use to buy gold at spot on the Comex Exchange.

In all activities of this sort it is highly advisable to consult with your financial advisers and brokers before embarking on any futures contracts.

Real Gold & Silver vs Gold & Silver Spot Price
Currently there is an unprecedented shortage of physical metal in the real gold and silver bullion markets. It is very difficult to buy physical gold and silver and the premiums (the amount over the spot price charged by dealers) are the highest since the 1980s and the waiting period is blowing out to 8 weeks or more for delivery.

In view of the increasing financial instability now worldwide, more and more people than ever are seeking physical gold and silver.

Yet, after an understandable climb in the gold and silver prices during the middle of the year when the 'credit crisis' really began to emerge, the spot price of gold and silver is falling. This is contrary to normal economics as, traditionally, in any past crisis , the value of gold and silver would consistently rise.

But nowadays, the spot price and the comex price, no longer reflect the true price of gold and silver in the market. Why is this so one might ask? Usually one would expect when a shortage of a commodity occurs, then the price would rise commensurate with the unavailability, and then more of the commodity should enter the market to make up the short fall, resulting in a balance being struck between the price and the commodity. Yet here we have a widening gap between the 'apparent' price of gold and silver and the availability of it.

To answer this conundrum and, possibly take advantage of it, we need to look at a number of issues. The first of which is, what is the comex or spot price of gold and silver?

If you already understand about the Comex you can skip this part.

What is the Comex
There used to be two exchanges in New York. The New York Mercantile Exchange and the Commodity Exchange, Inc (COMEX). In 2006 these two exchanged merged and became one. It is now the New York Mercantile Exchange (NYMEX) but is divided into two parts, the NYMEX Division upon which is traded such commodities as oil, gas, palladium and platinum and so forth, and the COMEX Division on which gold, silver copper and aluminum is traded. It is this exchange that we are most interested in. On this exchange are traded 'Future Contracts' of gold and silver.

Futures Trading
Futures trading is the basic action of entering into a legal contractual agreement with another (known or usually not known) individual to exchange money or assets of some value at some time in the future and with the pre-determined price (called a futures price) based on the underlying asset. Such an asset could be stock, an interest rate even or, in this case gold.

It is an agreement to exchange the underlying asset, or equivalent cash flows, at a future date.

In other words if you enter into such a contract you are betting that the value or price of that asset or stock or gold is going to be at a certain value at a predetermined time in the future. At that time, when the contact is completed and 'settlement date' arrives, you or the other party cough up with the difference between what was originally paid and what the settlement price is.

One of the perceived advantages of futures trading is that you do not have to put up all the money needed for the contract but usually only a percentage. Usually around 10 percent. This means that people can trade with a smaller amount. It is rather like going to the races and placing a bet for 1000 dollars but only putting 100 dollars down. If you lose you have to come up with the 1000 dollars of course but if you win you have only needed 100 dollars to play the game. There are some other factors of course that an investor in futures trading can come a cropper with, such as a drop in the price of the commodity resulting in more money being demanded of one by the broker. This happens only too often and many people over commit themselves and so can lose more than the shirt of their back this way. It takes good knowledge and due diligence and an excellent financial advisers and broker to play in the futures market.

Both parties of a futures contract must fulfill the contract on the settlement date. The seller then delivers the commodity to the buyer, or, more often than not, it is a cash-settled future, and cash is transferred from the futures trader who sustained a loss to the one who made a profit.

Incidentally, you can bet both ways of course, that the price will go up or down.

Gold & Silver Futures Trading
In this case the futures traded are gold or silver and done through the Comex, the marketplace where one buys and sells specific quantities of gold or silver, in the form of a futures contract, at a specified price with delivery set at a specified time in the future. The preset price is called the futures price and the delivery date is called the settlement price.

In Gold and silver future trading, the precious metal is usually not delivered but a cash settlement is affected. Many institutions who by gold and silver futures contracts, especially banks, will sell short, or in other words sell before the contract expires. However, we are going to look at how one can see the contract through to expiry and then accept delivery of physical gold and silver

What happened with the Comex?
Firstly, to help understand how this works, we might ask the question, why is the Comex price of gold and silver so much lower than the real price of gold and silver?

The “Resource Investor” (www.resourceinvestor.com) noted recently, "In that CFTC (Commodities Futures Trading Commission) report, it surfaced that those few banks took the huge net short positions in gold and silver futures just ahead of the largest and harshest fall in prices for gold and silver since the Great Gold Bull began in 2001 – 2002. The 'Got Gold Report' covered it from the silver point of view earlier this week."

This means that, artificially through a process of short selling on contracts, the price of gold and silver was driven down as part of the effort to boost up the dollar. Of course this only affected the COMEX gold and silver price and had no effect on the real price of gold and silver, which is demonstrably in short supply, except to focus more attention on the ever widening gap between the two.

This has consequently opened up the opportunity for investors and traders in gold and silver to buy at the Comex Price and sell on the open market. There are some costs issues to overcome but these are minor when you look at the difference in the price of the Comex and physical metal.

How to Buy Gold and Silver on the Comex
Taking delivery of a commodity is not usual and some brokers might try and talk you out of it as it involves more work for them. Something they are not keen to do. So you will have to find a broker willing to do the work and be insistent about taking delivery. It is quite legal and in fact that is what the market was originally designed to do.

The following outlines the basics, including the various procedures involved in taking delivery of a gold or silver future contract on the Comex. There are some costs involved of course which will vary with the broker you use.

Whereas, with a cash market you can buy or sell during the term of a contract, to take delivery you will need to wait until the term of the contract expires and you can take delivery. This is called taking a long term. Various entities, such as banks for example, take a short term. They have no intention of taking deliver and so, with the ten percent leverage (remember?) they can take enormous amounts of contracts and sell them short, keeping the price down and, in effect, manipulating the gold and silver price.

But if you intend to take possession you will have to ante up the whole amount required to complete that contract and you would have to wait until the contract expires before you can organise and take delivery.

For example, if a contract was bought today, and the price on the gold contract was between $695 - $735 per ounce, the full value of the contract you bought would be $69,500 - $73,500 per 100-troy ounce. Likewise if the price on the silver contract was between $9.74 - $9.16 per ounce, then it would be $48,700 - $45,800 per 5,000 troy-ounce contract.

These figures would not include any commission charges incurred going through a broker of course and are just an example to illustrate how it works.

Of course, if you did not want to take possession of the metal you could simply enter a position without posting the full contract value, but instead post around 10 percent (The actual percentage may vary depending on your broker and other factors). This is the "margin" which is posted "in good faith". Price can go through some dramatic changes in the any futures market and if the price of gold drops significantly you might be called upon to add funds to your account to maintain your position. (called a maintenance margin) or you might find your position is liquidated. There is usually a risk maintenance level and if your account falls below that level then you would need to top up your account with the requisite funds.

Now, when the time comes to take delivery you will get a Notice of Delivery and the full amount will be debited from your account. So you would be required to have the full contract value deposited in your account with your broker at the price the contract was originally purchased. There would be a few days of processing at the end of the contract but then you would be able to take possession, usually a couple of weeks later.

You can do this in three ways.

You will receive a receipt, which in effect is like a stock certificate, and you could store that. The gold would be in storage in a vault and you would be up for some storage charges, This premium, compared to the gold price, will be minuscule. The gold is kept in storage for you and you can take physical delivery anytime you want of course. This is the first method.

The second is that you could have the gold bullion shipped to a warehouse. You can be put in touch with the vault that contains your gold (generally in or around New York, US) and have brinks or an Armored car transfer your gold to a warehouse or bank of your choosing. There would be more costs involved with this but, again, the charges would not be very much compared to the value of the gold bullion.

Of course you can avoid doing any of this by simply depositing the full value of the contract when you establish the position. Note, you can decide not to take delivery of course at any time and close out your metals position and take a profit or loss depending on the price movement.

Price and Delivery Costs
Usually when the contract is expired and delivered to you it is in the form of a Certificate. Many clients have the broker hold their certificate so the contract can be sold back into the market at a later date. However, In this case you want to take delivery so you would get the certificate from the broker.

The costs involved now will depend upon your broker, usually there is a contract fee and a commission, as well as insurance and storage fees. The gold can stay where it is and simply be stored for a regular fee.

However, IF you want to take it out of the Comex warehouse and have it stored elsewhere then it would be your responsibility to organise this. This would be typically done through a security shipping service and arranged storage at a bank vault.

In order to sell the gold or silver back on the comex there is also the addition action required which is to have the gold assayed (assayed: an analysis of a metal to determine the quality and weight of the metal). Any gold removed from the Comex Warehouse must be assayed prior to being sold again on the comex. So this would be an additional cost if you planned to sell it there in the future. However, you can sell the gold or silver to a gold dealer any time without having to have it assayed.

If your intent is to actually receive the physical metal, it is held in storage at specific "delivery points." It is your responsibility to make the arrangements to do this. There are fees associated with removal from the storage facility. In addition, if the metal is taken out of storage, it cannot be sold for delivery on the exchange without being re-assayed.

Some people actually turn up with a SUV, their receipt or certificate and have the gold loaded into the back of the SUV and drive off with it. Not something to tell the neighbors of course.

Of course to do all of this one needs to have an account with a broker who handles, or preferably specializes, in Commodity futures trading on the Comex. You will need to set up an account whereby you have access to broker-assisted trading rather than just trading online.

In step form it goes like this:

Broker holds the receipt in PFG's account for customer
Client buys the futures contract.
Client will take delivery between First Notice Day and the Last Trading Day.
On delivery day account is debited cost plus a small delivery fee.
Receipt is booked to customers account
Monthly storage charge also passed on to customer's account.

For Physical Delivery when the Customer wants the gold or silver bars in their procession
Client buys the futures contract.
Client will take delivery between First Notice Day and the Last Trading Day.
On delivery day account is debited cost plus a small delivery fee.
The broker provides the customer with name and phone number of the individual at the depository to
contact.
Customer makes arrangements for the physical delivery including having the gold or silver assayed if required in order to sell to a dealer.

Last word on Buying Gold and Silver on the Comex
For the new person or one inexperienced in futures trading, it is advisable to only use funds which you can happily afford to lose. It is also advisable to have a broker who fully understands gold and silver futures trading and with which one can build up a relationship. Also always seek the advice of a competent financial adviser prior to making any investment.

Buying gold or silver on the Comex can be a very fruitful exercise and following the above outlines and point will help you to understand a bit more fully how to buy gold and silver on the Comex.

A Trader's Guide To Using Fractals - by Justin Kuepper

Many people believe that the markets are random. In fact, one of the most prominent investing books out there is "A Random Walk Down Wall Street" (1973) by Burton G. Malkiel, who argues that throwing darts at a dartboard is likely to yield results similar to those achieved by a fund manager (and Malkiel does have many valid points). 

However, many others argue that although prices may appear to be random, they do in fact follow a pattern in the form of trends. One of the most basic ways in which traders can determine such trends is through the use of fractals. Fractals essentially break down larger trends into extremely simple and predictable reversal patterns. This article will explain what fractals are and how you might apply them to your trading to enhance your profits.

What Are Fractals? When many people think of fractals in the mathematical sense, they think of chaos theory and abstract mathematics. While these concepts do apply to the market (it being a nonlinear, dynamic system), most traders refer to fractals in a more literal sense. That is, as recurring patterns that can predict reversals among larger, more chaotic price movements.
These basic fractals are composed of five or more bars. The rules for identifying fractals are as follows:

• A bearish turning point occurs when there is a pattern with the highest high in the middle and two lower highs on each side.
• A bullish turning point occurs when there is a pattern with the lowest low in the middle and two higher lows on each side.

The fractals shown in Figure 1 are two examples of perfect patterns. Note that many other less perfect patterns can occur, but the basic pattern should remain intact for the fractal to be valid.

Figure 1

The obvious drawback here is that fractals are lagging indicators - that is, a fractal can't be drawn until we are two days into the reversal. While this may be true, most significant reversals last many more bars, so most of the trend will remain intact (as we will see in the example below).

Applying Fractals to Trading
Like many trading indicators, fractals are best used in conjunction with other indicators or forms of analysis. Perhaps the most common confirmation indicator used with fractals is the "Alligator indicator", a tool that is created by using moving averages that factor in the use of fractal geometry. The standard rule states that all buy rules are only valid if below the "alligator's teeth" (the center average), and all sell rules are only valid if above the alligator's teeth.

Figure 2 is an example of such a setup:

Figure 2

As you can see, the primary drawback to this system is the large swings that take place. Notice, for example, that the latest fractal had a drawdown of over 100 pips and still has not hit an exit point. However, there are countless other techniques that can be applied in conjunction with fractals to produce profitable trading systems.

Figure 3 shows a forex trading setup that uses a combination of fractals (multiple time frames), Fibonacci-based moving averages (placed at 89, 144, 233, 377 and their inverses) and a momentum indicator. Let's look at a recent trade setup for the GBP/USD currency pair to see how fractals can help:

Figure 3

Here is a basic rule setup that is used when using a chart with a four-hour time frame:

• Initiate a position when the price has hit the farthest Fibonacci band, but only after a daily (D1) fractal takes place.
• Exit a position after a daily (D1) fractal reversal takes place.

Notice how the fractals pinpoint meaningful tops and bottoms? This helps to take the guesswork out of deciding at which Fibonacci level to trade - all we have to do is check to see if the daily fractal occurred. We should also note that the trend strength began increasing at the sell fractal, and topped at the buy fractal. Although we lose some pips with the confirmation, it saves us from losing out on mere market noise - 139 pips certainly isn't bad for three days! (For further reading, see Trading Without Noise.)

Things to Consider
Here are a few things to remember when using fractals:

• They are lagging indicators. They are best used as confirmation indicators to help confirm that a reversal did take place. Real-time tops and bottoms can be surmised with other techniques.
• The longer the time period (i.e. the number of bars required for a fractal), the more reliable the reversal. However, you should also remember that the longer the time period, the lower the number of signals generated.
• It is best to plot fractals in multiple time frames and use them in conjunction with one another. For example, only trade short-term fractals in the direction of the long-term ones. Along these same lines, long-term fractals are more reliable than short-term fractals.
• Always use fractals in conjunction with other indicators or systems. They work best as decision support tools, not as indicators on their own.

Conclusion
As you can see, fractals can be extremely powerful tools when used in conjunction with other indicators and techniques, especially when used to confirm reversals. The most common usage is with the "Alligator indicator"; however, there are other uses too, as we've seen here. Overall, fractals make excellent decision support tools for any trading method.

Resources
These are the two main charting packages that contain fractals:

• MetaTrader for forex
• TradeStation for equities (via plug-in)

If you want to know more about chaos theory and its applications in the marketplace, an excellent book on the topic is "Profiting From Chaos" (1994) by Tonis Vaga

A Forex Trader's View Of The Aussie/Gold Relationship

The relationships between different financial markets are almost as old as the markets themselves. For example, in many cases when benchmark equities rise, bonds fall. Many traders will watch for correlations like this and try to capitalize on the opportunity. The same types of relationships exist in the global foreign exchange market. Take for instance the closely related tie between the Australian dollar and gold. Due mostly to the fact that Australia remains a major producer of the yellow metal, the correlation is an opportunity that not only exists, but is one that traders on every level can capitalize on. Let's take a look at why this relationship exists, and how you can use it to produce solid gold returns.

Being Productive Is KeyThe U.S. dollar/crude oil relationship exists for one simple reason: the commodity is priced in dollars. However, the same cannot be said about the Aussie correlation. The gold/Australian dollar relationship stems from production. As of 2008, Australia was ranked as the fourth-largest gold producer in the world, coming in behind China, South Africa and the United States. Even though it may not be the largest producer, the "Land Down Under" produces an estimated 225 metric tons of gold per year, according to the consultancy firm GFMS. As a result, it is only natural that the underlying currency of a major commodity producer follows a similar pattern to that commodity. With the ebb and flow of production, the exchange rate will follow supply and demand as money exchanges hands between miner and manufacturer. (For related reading, see Commodity Prices And Currency Movements.)

According to a 2005 GFMS survey, the last time Australia was ranked second in production behind South Africa, gold production in the South Pacific economy was at a height of approximately 263 tons per year. This volume made up a commanding 10.4% of the market. However, steadily but surely, production has been decreasing year over year (YOY), helping to drive prices higher. Ultimately, the shorter supply of gold has helped to create demand for the Australian dollar, which moved in lockstep with the commodity until mid-2008. If an investor or trader had taken advantage of this simple correlation, he or she would have earned an approximate 30% rate of return on the currency price alone (aside from any rollover interest associated with the trade). (For more, see Using Currency Correlations To Your Advantage.)

Capitalizing on the RelationshipAlthough the macro strategy does work on all levels, it is best suited for portfolios that are set in longer time frames. Traders are not going to see strong correlations on every single day of trading, much like other broader market dynamics. As a result, it's advantageous to cushion the blow of daily volatility and risk through a longer time horizon.

Fundamentally oriented traders will tend to trade one or both instruments, taking trading cues from the other. These cues can be gathered from a list of topics including:

1. Commodity Reserve Reports
2. COT Futures Reports
3. Australian Economic Developments
4. Interest Rates
5. Safe Haven Investing

As a result, these trades tend to be longer than day-trade considerations as the portfolio is looking to capture the overall market tone rather than just an intraday pop or drop.

Technically, traders tend to find their cues in technical formations with the hope that corresponding correlations will seep into the related market. Whether the formation is in the gold chart or the Aussie chart, it is better to find one solid formation first, rather than looking for both charts to correlate perfectly. An example of this is clearly seen in the chart examples below. 

Figure 1

Source: FX Trek Intellicharts

 

Figure 2

Source: MetaTrader

As shown in Figure 2, with the market in turmoil and investor deleveraging that was "en vogue" in 2008, traders saw an opportunity to jump on the bandwagon as both Aussie and gold experienced a temporary uptick in price. Already knowing that this would be a blow-off top in an otherwise bearish market, the savvy technical investor could visibly see both assets moving in sync. As a result, technically speaking, a short opportunity shone through as the commodity approached the $905.50 figure, which corresponded with the pivotal 0.8500 figure in the FX market. The double top in gold all but ensured further depression in the Australian dollar/U.S. dollar currency pair. (For more insight, see The Midas Touch For Gold Investors.)

Trying It Out: a Trade Setup
Now let's take a look at a shorter trade setup involving both the Australian dollar and gold.

First, the broad macro picture. Taking a look at Figure 2, we see that gold has taken a hard dive down as investors and traders have deleveraged and sold off riskier assets. Following this move, subsequent consolidation lends to the belief that a turnaround may be lingering in the market. The idea is supported by the likelihood that equity investors will elect to move some money into the safe haven characteristic of the commodity as global benchmark indexes continue to decline in value. (To read more about gold's reputation as a safe haven, see 8 Reasons To Own Gold.)
 

Figure 3

Source: MetaTrader

We see a similar position developing in the Australian dollar following a spike down to just below the 0.6045 figure, shown in Figure 4 below. At this time, the currency was under extreme pressure as global speculators deemed the Australian dollar a risky currency. Putting these two factors together, portfolio direction is looking to be upward.

Next, we take a look at our charts and apply basic support and resistance techniques. Following our initial trade idea with gold, we first project a textbook channel to our chart as price action has displayed three defining technical points (labeled A, B and C). The gold channel corresponds with a short-term channel developing in the AUD/USD currency pair in Figure 4.      

Figure 4

Source: MetaTrader

The combination culminates on December 10, 2008 (Figure 3 Point C). Not only do both assets test the support or lower channel trendline, but we also have a bullish MACD convergence confirming the move higher in the AUD/USD currency pair. 

Finally, we place the corresponding entry at the close of the session, 0.6561. The subsequent stop would be placed at the swing low. In this case, that would be the December 5 low of 0.6290, a roughly 271 pip stop. Taking proper risk/reward management into account, we place our target at 0.7103 to give us a 2:1 risk-to-reward ratio. Luckily, the trade takes no longer than a week as the target is triggered on December 18 for a 542 pip profit.

Conclusion
Intermarket strategies like the Australian dollar and gold present ample opportunities for the savvy investor and trader. Whether it's to produce a higher profit/loss ratio or increase overall portfolio returns, market correlations are sure to add value to a market participant's repertoire.

Getting Started in Foreign Exchange Futures - By Justin Kuepper,

The spot foreign exchange (forex or FX) market is the world's largest market, with over one trillion U.S. dollars traded per day. One derivative of this market is the forex futures market, which is only 1/100th the size. This article examines the key differences between forex futures and traditional futures and looks at some strategies for speculating and hedging with this useful derivative.

Forex Futures versus Traditional Futures
Both forex and traditional futures operate in the same basic manner: a contract is purchased to buy or sell a specific amount of an asset at a particular price on a predetermined date. (For an in-depth introduction to futures, see Futures Fundamentals.) There is, however, one key difference between the two: forex futures are not traded on a centralized exchange; rather, the deal flow is available through several different exchanges in the U.S. and abroad. The vast majority of forex futures are traded through the Chicago Mercantile Exchange (CME) and its partners (introducing brokers).

However, this is not to say that forex futures contracts are OTCforward contracts). It is important to remember that all currency futures quotes are made against the U.S. dollar, unlike the spot forex market.

Here is an example of what a forex futures quote looks like:
per se; they are still bound to a designated 'size per contract,' and they are offered only in whole numbers (unlike

Euro FX Futures on the CME
For any given futures contract, your broker should provide you with its specifications, such as the contract sizes, time increments, trading hours, pricing limits, and other relevant information. Here is an example of what a specification sheet might look like:


Specification Sheet from CME

Hedging versus Speculating
Hedging and speculating are the two primary ways in which forex derivatives are used. Hedgers use forex futures to reduce or eliminate risk by insulating themselves against any future price movements. Speculators, on the other hand, want to incur risk in order to make a profit. Now, let's take a more in-depth look at these two strategies:

Hedging
There are many reasons to use a hedging strategy in the forex futures market. One main purpose is to neutralize the effect of currency fluctuations on sales revenue. For example, if a business operating overseas wanted to know exactly how much revenue it will obtain (in U.S. dollars) from its European stores, it could purchase a futures contract in the amount of its projected net sales to eliminate currency fluctuations.

When hedging, traders must often choose between futures and another derivative known as a forward. There are several differences between these two instruments, the most notable of which are these:

• Forwards allow the trader more flexibility in choosing contract sizes and setting dates. This allows you to tailor the contracts to your needs instead of using a set contract size (futures).

• The cash that's backing a forward is not due until the expiration of the contract, whereas the cash behind futures is calculated daily, and buyer and seller are held liable for daily cash settlements. By using futures, you have the ability to re-evaluate your position as often as you like. With forwards, you must wait until the contract expires.

Speculating
Speculating is by nature profit-driven. In the forex market, futures and spot forex are not all that different. So why exactly would you want to participate in the futures market instead of the spot market? Well, there are several arguments for and against trading in the futures market:

Advantages
• Lower spreads (2-3).
• Lower transaction costs (as low as $5 per contract).
• More leverage (often $500+ per contract).

Disadvantages
• Often requires a higher amount of capital ($100,000 lots).
• Limited to the exchange's session times.
• NFA (National Futures Association) fees may apply.

The strategies employed for speculating are similar to those used in spot markets. The most widely used strategies are based on common forms of technical chart analysis since these markets tend to trend well. These include Fibonacci studies, Gann studies, pivot points, and other similar techniques. Alternately, some speculators use more advanced strategies, such as arbitrage.

Conclusion
As we can see, forex futures operate similarly to traditional stock and commodity futures. There are many advantages to using them for hedging as well as speculating. The distinguishing feature of forex futures is that they are not traded on a centralized exchange. Forex futures can be used to hedge against currency fluctuations, but some traders use these instruments in pursuit of profit, just as they would use futures on the spot market.

Futures Fundamentals - Part 2

5. Characteristics

In the futures market, margin has a definition distinct from its definition in the stock market, where margin is the use of borrowed money to purchase securities. In the futures market, margin refers to the initial deposit of  "good faith" made into an account in order to enter into a futures contract. This margin is referred to as good faith because it is this money that is used to debit any day-to-day losses.  

When you open a futures contract, the futures exchange will state a minimum amount of money that you must deposit into your account. This original deposit of money is called the initial margin. When your contract is liquidated, you will be refunded the initial margin plus or minus any gains or losses that occur over the span of the futures contract. In other words, the amount in your margin account changes daily as the market fluctuates in relation to your futures contract. The minimum-level margin is determined by the futures exchange and is usually 5% to 10% of the futures contract. These predetermined initial margin amounts are continuously under review: at times of high market volatility, initial margin requirements can be raised.

The initial margin is the minimum amount required to enter into a new futures contract, but the maintenance margin is the lowest amount an account can reach before needing to be replenished. For example, if your margin account drops to a certain level because of a series of daily losses, brokers are required to make a margin call and request that you make an additional deposit into your account to bring the margin back up to the initial amount.

Let's say that you had to deposit an initial margin of $1,000 on a contract and the maintenance margin level is $500. A series of losses dropped the value of your account to $400. This would then prompt the broker to make a margin call to you, requesting a deposit of at least an additional $600 to bring the account back up to the initial margin level of $1,000.

Word to the wise: when a margin call is made, the funds usually have to be delivered immediately. If they are not, the brokerage can have the right to liquidate your position completely in order to make up for any losses it may have incurred on your behalf.

Leverage: The Double-Edged Sword

 
In the futures market, leverage refers to having control over large cash amounts of commodities with comparatively small levels of capital. In other words, with a relatively small amount of cash, you can enter into a futures contract that is worth much more than you initially have to pay (deposit into your margin account). It is said that in the futures market, more than any other form of investment, price changes are highly leveraged, meaning a small change in a futures price can translate into a huge gain or loss.

Futures positions are highly leveraged because the initial margins that are set by the exchanges are relatively small compared to the cash value of the contracts in question (which is part of the reason why the futures market is useful but also very risky). The smaller the margin in relation to the cash value of the futures contract, the higher the leverage. So for an initial margin of $5,000, you may be able to enter into a long position in a futures contract for 30,000 pounds of coffee valued at $50,000, which would be considered highly leveraged investments.

You already know that the futures market can be extremely risky and,therefore, not for the faint of heart. This should become more obvious once you understand the arithmetic of leverage. Highly leveraged investments can produce two results: great profits or greater losses.

As a result of leverage, if the price of the futures contract moves up even slightly, the profit gain will be large in comparison to the initial margin. However, if the price just inches downwards, that same high leverage will yield huge losses in comparison to the initial margin deposit. For example, say that in anticipation of a rise in stock prices across the board, you buy a futures contract with a margin deposit of $10,000, for an index currently standing at 1300. The value of the contract is worth $250 times the index (e.g. $250 x 1300 = $325,000), meaning that for every point gain or loss, $250 will be gained or lost.

If after a couple of months, the index realized a gain of 5%, this would mean the index gained 65 points to stand at 1365. In terms of money, this would mean that you as an investor earned a profit of $16,250 (65 points x $250); a profit of 162%!

On the other hand, if the index declined 5%, it would result in a monetary loss of $16,250 - a huge amount compared to the initial margin deposit made to obtain the contract. This means you still have to pay $6,250 out of your pocket to cover your losses. The fact that a small change of 5% to the index could result in such a large profit or loss to the investor (sometimes even more than the initial investment made) is the risky arithmetic of leverage. Consequently, while the value of a commodity or a financial instrument may not exhibit very much price volatility, the same percentage gains and losses are much more dramatic in futures contracts due to low margins and high leverage.

Pricing and Limits

 
As we mentioned before, contracts in the futures market are a result of competitive price discovery. Prices are quoted as they would be in the cash market: in dollars and cents or per unit (gold ounces, bushels, barrels, index points, percentages and so on).

Prices on futures contracts, however, have a minimum amount that they can move. These minimums are established by the futures exchanges and are known as “ticks.” For example, the minimum sum that a bushel of grain can move upwards or downwards is a quarter of one U.S. cent. For futures investors, it's important to understand how the minimum price movement for each commodity will affect the size of the contract in question. If you had a wheat contract for 5,000 bushels, the minimum price movement would be $12.50 ($0.0025 x 5,000).

Futures prices also have a price change limit that determines the prices between which the contracts can trade on a daily basis. The price change limit is added to and subtracted from the previous day's close and the results remain the upper and lower price boundary for the day.

Say that the price change limit on silver per ounce is $0.25. Yesterday, the price per ounce closed at $5. Today's upper price boundary for silver would be $5.25 and the lower boundary would be $4.75. If at any moment during the day the price of futures contracts for silver reaches either boundary, the exchange shuts down all trading of silver futures for the day. The next day, the new boundaries are again calculated by adding and subtracting $0.25 to the previous day's close. Each day the silver ounce could increase or decrease by $0.25 until an equilibrium price is found. Because trading shuts down if prices reach their daily limits, there may be occasions when it is NOT possible to liquidate an existing futures position at will.

The exchange can revise this price limit if it feels it's necessary. It's not uncommon for the exchange to abolish daily price limits in the month that the contract expires (delivery or “spot” month). This is because trading is often volatile during this month, as sellers and buyers try to obtain the best price possible before the expiration of the contract.

In order to avoid any unfair advantages, the CTFC and the futures exchanges impose limits on the total amount of contracts or units of a commodity in which any single person can invest. These are known as position limits and they ensure that no one person can control the market price for a particular commodity.  

6. Strategies

Essentially, futures contracts try to predict what the value of an index or commodity will be at some date in the future. Speculators in the futures market can use different strategies to take advantage of rising and declining prices. The most common are known as going long,  going short and spreads. 

Going Long
When an investor goes long - that is, enters a contract by agreeing to buy and receive delivery of the underlying at a set price - it means that he or she is trying to profit from an anticipated future price increase.

For example, let's say that, with an initial margin of $2,000 in June, Joe the speculator buys one September contract of gold at $350 per ounce, for a total of 1,000 ounces or $350,000. By buying in June, Joe is going long, with the expectation that the price of gold will rise by the time the contract expires in September.

By August, the price of gold increases by $2 to $352 per ounce and Joe decides to sell the contract in order to realize a profit. The 1,000 ounce contract would now be worth $352,000 and the profit would be $2,000. Given the very high leverage (remember the initial margin was $2,000), by going long, Joe made a 100% profit!

Of course, the opposite would be true if the price of gold per ounce had fallen by $2. The speculator would have realized a 100% loss. It's also important to remember that throughout the time that Joe held the contract, the margin may have dropped below the maintenance margin level. He would, therefore, have had to respond to several margin calls, resulting in an even bigger loss or smaller profit.

Going Short
A speculator who goes short - that is, enters into a futures contract by agreeing to sell and deliver the underlying at a set price - is looking to make a profit from declining price levels. By selling high now, the contract can be repurchased in the future at a lower price, thus generating a profit for the speculator.

Let's say that Sara did some research and came to the conclusion that the price of oil was going to decline over the next six months. She could sell a contract today, in November, at the current higher price, and buy it back within the next six months after the price has declined. This strategy is called going short and is used when speculators take advantage of a declining market.

Suppose that, with an initial margin deposit of $3,000, Sara sold one May crude oil contract (one contract is equivalent to 1,000 barrels) at $25 per barrel, for a total value of $25,000.

By March, the price of oil had reached $20 per barrel and Sara felt it was time to cash in on her profits. As such, she bought back the contract which was valued at $20,000. By going short, Sara made a profit of $5,000! But again, if Sara's research had not been thorough, and she had made a different decision, her strategy could have ended in a big loss.

Spreads
As you can see, going long and going short are positions that basically involve the buying or selling of a contract now in order to take advantage of rising or declining prices in the future. Another common strategy used by futures traders is called “spreads.”

Spreads involve taking advantage of the price difference between two different contracts of the same commodity. Spreading is considered to be one of the most conservative forms of trading in the futures market because it is much safer than the trading of long/short (naked) futures contracts.

There are many different types of spreads, including:

Calendar Spread - This involves the simultaneous purchase and sale of two futures of the same type, having the same price, but different delivery dates. Intermarket Spread - Here the investor, with contracts of the same month, goes long in one market and short in another market. For example, the investor may take Short June Wheat and Long June Pork Bellies. Inter-Exchange Spread - This is any type of spread in which each position is created in different futures exchanges. For example, the investor may create a position in the Chicago Board of Trade (CBOT) and the London International Financial Futures and Options Exchange (LIFFE).

7. How To Trade 

At the risk of repeating ourselves, it's important to note that  futures trading is not for everyone. You can invest in the futures market in a number of different ways, but before taking the plunge, you must be sure of the amount of risk you're willing to take. As a futures trader, you should have a solid understanding of how the market and contracts function. You'll also need to determine how much time, attention, and research you can dedicate to the investment. Talk to your broker and ask questions before opening a futures account.

 

Unlike traditional equity traders, futures traders are advised to only use funds that have been earmarked as pure "risk capital"- the risks really are that high. Once you've made the initial decision to enter the market, the next question should be “How?” Here are three different approaches to consider:

Do It Yourself - As an investor, you can trade your own account without the aid or advice of a broker. This involves the most risk because you become responsible for managing funds, ordering trades, maintaining margins, acquiring research and coming up with your own analysis of how the market will move in relation to the commodity in which you've invested. It requires time and complete attention to the market.

Open a Managed Account - Another way to participate in the market is by opening a managed account, similar to an equity account. Your broker would have the power to trade on your behalf, following conditions agreed upon when the account was opened. This method could lessen your financial risk because a professional would be making informed decisions on your behalf. However, you would still be responsible for any losses incurred as well as for margin calls. And you'd probably have to pay an extra management fee.

Join a Commodity Pool - A third way to enter the market, and one that offers the smallest risk, is to join a commodity pool. Like a mutual fund, the commodity pool is a group of commodities which can be invested in. No one person has an individual account; funds are combined with others and traded as one. The profits and losses are directly proportionate to the amount of money invested. By entering a commodity pool, you also gain the opportunity to invest in diverse types of commodities. You are also not subject to margin calls. However, it is essential that the pool be managed by a skilled broker, because the risks of the futures market are still present in the commodity pool.

8. Conclusion

 

Buying and selling in the futures market can seem risky and complicated. As we've already said, futures trading is not for everyone, but it works for a wide range of people. This tutorial has introduced you to the fundamentals of futures. If you want to know more, talk to your broker. 

Let's review the basics:

• The futures market is a global marketplace, initially created as a place for farmers and merchants to buy and sell commodities for either spot or future delivery. This was done to lessen the risk of both waste and scarcity.
• Rather than trade in physical commodities, futures markets buy and sell futures contracts, which state the price per unit, type, value, quality and quantity of the commodity in question, as well as the month the contract expires.
• The players in the futures market are hedgers and speculators. A hedger tries to minimize risk by buying or selling now in an effort to avoid rising or declining prices. Conversely, the speculator will try to profit from the risks by buying or selling now in anticipation of rising or declining prices.
• The CFTC and the NFA are the regulatory bodies governing and monitoring futures markets in the U.S. It is important to know your rights.
• Futures accounts are credited or debited daily depending on profits or losses incurred. The futures market is also characterized as being highly leveraged due to its margins; although leverage works as a double-edged sword. It's important to understand the arithmetic of leverage when calculating profit and loss, as well as the minimum price movements and daily price limits at which contracts can trade.
• “Going long,” “going short,” and “spreads” are the most common strategies used when trading on the futures market.
• Once you make the decision to trade in commodities, there are several ways to participate in the futures market. All of them involve risk -  some more than others. You can trade your own account, have a managed account or join a commodity pool. 

Futures Fundamentals - Part 1

1. Introduction

A futures contract is a type of derivative instrument, or financial contract, in which two parties agree to transact a set of financial instruments or physical commodities for future delivery at a particular price. If you buy a futures contract, you are basically agreeing to buy something that a seller has not yet produced for a set price. But participating in the futures market does not necessarily mean that you will be responsible for receiving or delivering large inventories of physical commodities - remember, buyers and sellers in the futures market primarily enter into futures contracts to hedge risk or speculate rather than to exchange physical goods (which is the primary activity of the cash/spot market). That is why futures are used as financial instruments by not only producers and consumers but also speculators.

The consensus in the investment world is that the futures market is a major financial hub, providing an outlet for intense competition among buyers and sellers and, more importantly, providing a center to manage price risks. The futures market is extremely liquid, risky and complex by nature, but it can be understood if we break down how it functions.

While futures are not for the risk averse, they are useful for a wide range of people. In this tutorial, you'll learn how the futures market works, who uses futures and which strategies will make you a successful trader on the futures market. 

2. History

Before the North American futures market originated some 150 years ago, farmers would grow their crops and then bring them to market in the hope of selling their inventory. But without any indication of demand, supply often exceeded what was needed and unpurchased crops were left to rot in the streets! Conversely, when a given commodity - wheat, for instance - was out of season, the goods made from it became very expensive because the crop was no longer available. 

In the mid-nineteenth century, central grain markets were established and a central marketplace was created for farmers to bring their commodities and sell them either for immediate delivery (spot trading) or for forward delivery. The latter contracts - forward contracts - were the forerunners to today's futures contracts. In fact, this concept saved many  a farmer the loss of crops and profits and helped stabilize supply and prices in the off-season.

Today's futures market is a global marketplace for not only agricultural goods, but also for currencies and financial instruments such as Treasury bonds and securities (securities futures). It's a diverse meeting place of farmers, exporters, importers, manufacturers and speculators. Thanks to modern technology, commodities prices are seen throughout the world, so a Kansas farmer can match a bid from a buyer in Europe.  

3. How The Market Works

The futures market is a centralized marketplace for buyers and sellers from around the world who meet and enter into futures contracts. Pricing can be based on an open cry system, or bids and offers can be matched electronically. The futures contract will state the price that will be paid and the date of delivery. But don't worry, as we mentioned earlier, almost all futures contracts end without the actual physical delivery of the commodity. 

What Exactly Is a Futures Contract? Let's say, for example, that you decide to subscribe to cable TV. As the buyer, you enter into an agreement with the cable company to receive a specific number of cable channels at a certain price every month for the next year. This contract made with the cable company is similar to a futures contract, in that you have agreed to receive a product at a future date, with the price and terms for delivery already set. You have secured your price for now and the next year - even if the price of cable rises during that time. By entering into this agreement with the cable company, you have reduced your risk of higher prices.

That's how the futures market works. Except instead of a cable TV provider, a producer of wheat may be trying to secure a selling price for next season's crop, while a bread maker may be trying to secure a buying price to determine how much bread can be made and at what profit. So the farmer and the bread maker may enter into a futures contract requiring the delivery of 5,000 bushels of grain to the buyer in June at a price of $4 per bushel. By entering into this futures contract, the farmer and the bread maker secure a price that both parties believe will be a fair price in June. It is this contract - and not the grain per se - that can then be bought and sold in the futures market.

So, a futures contract is an agreement between two parties: a short position - the party who agrees to deliver a commodity -  and a long position - the party who agrees to receive a commodity. In the above scenario, the farmer would be the holder of the short position (agreeing to sell) while the bread maker would be the holder of the long (agreeing to buy). We will talk more about the outlooks of the long and short positions in the section on strategies, but for now it's important to know that every contract involves both positions.

In every futures contract, everything is specified: the quantity and quality of the commodity, the specific price per unit, and the date and method of delivery. The “price” of a futures contract is represented by the agreed-upon price of the underlying commodity or financial instrument that will be delivered in the future. For example, in the above scenario, the price of the contract is 5,000 bushels of grain at a price of $4 per bushel.

Profit And Loss - Cash Settlement
The profits and losses of a futures contract depend on the daily movements of the market for that contract and are calculated on a daily basis. For example, say the futures contracts for wheat increases to $5 per bushel the day after the above farmer and bread maker enter into their futures contract of $4 per bushel. The farmer, as the holder of the short position, has lost $1 per bushel because the selling price just increased from the future price at which he is obliged to sell his wheat. The bread maker, as the long position, has profited by $1 per bushel because the price he is obliged to pay is less than what the rest of the market is obliged to pay in the future for wheat.

On the day the change occurs, the farmer's account is debited $5,000 ($1 per bushel X 5,000 bushels) and the bread maker's account is credited by $5,000 ($1 per bushel X 5,000 bushels). As the market moves every day, these kinds of adjustments are made accordingly. Unlike the stock market, futures positions are settled on a daily basis, which means that gains and losses from a day's trading are deducted or credited to a person's account each day. In the stock market, the capital gains or losses from movements in price aren't realized until the investor decides to sell the stock or cover his or her short position.

As the accounts of the parties in futures contracts are adjusted every day, most transactions in the futures market are settled in cash, and the actual physical commodity is bought or sold in the cash market. Prices in the cash and futures market tend to move parallel to one another, and when a futures contract expires, the prices merge into one price. So on the date either party decides to close out their futures position, the contract will be settled. If the contract was settled at $5 per bushel, the farmer would lose $5,000 on the futures contract and the bread maker would have made $5,000 on the contract.

But after the settlement of the futures contract, the bread maker still needs wheat to make bread, so he will in actuality buy his wheat in the cash market (or from a wheat pool) for $5 per bushel (a total of $25,000) because that's the price of wheat in the cash market when he closes out his contract. However, technically, the bread maker's futures profits of $5,000 go towards his purchase, which means he still pays his locked-in price of $4 per bushel ($25,000 - $5,000 = $20,000). The farmer, after also closing out the contract, can sell his wheat on the cash market at $5 per bushel but because of his losses from the futures contract with the bread maker, the farmer still actually receives only $4 per bushel. In other words, the farmer's loss in the futures contract is offset by the higher selling price in the cash market - this is referred to as hedging.

Now that you see that a futures contract is really more like a financial position, you can also see that the two parties in the wheat futures contract discussed above could be two speculators rather than a farmer and a bread maker. In such a case, the short speculator would simply have lost $5,000 while the long speculator would have gained that amount. In other words, neither would have to go to the cash market to buy or sell the commodity after the contract expires.)

Economic Importance of the Futures Market
Because the futures market is both highly active and central to the global marketplace, it's a good source for vital market information and sentiment indicators.

Price Discovery - Due to its highly competitive nature, the futures market has become an important economic tool to determine prices based on today's and tomorrow's estimated amount of supply and demand. Futures market prices depend on a continuous flow of information from around the world and thus require a high amount of transparency. Factors such as weather, war, debt default, refugee displacement, land reclamation and deforestation can all have a major effect on supply and demand and, as a result, the present and future price of a commodity. This kind of information and the way people absorb it constantly changes the price of a commodity. This process is known as price discovery.


Risk Reduction - Futures markets are also a place for people to reduce risk when making purchases. Risks are reduced because the price is pre-set, therefore letting participants know how much they will need to buy or sell. This helps reduce the ultimate cost to the retail buyer because with less risk there is less of a chance that manufacturers will jack up prices to make up for profit losses in the cash market.

4. The Players

Hedgers
Farmers, manufacturers, importers and exporters can all be hedgers. A hedger buys or sells in the futures market to secure the future price of a commodity intended to be sold at a later date in the cash market. This helps protect against price risks.

The holders of the long position in futures contracts (the buyers of the commodity), are trying to secure as low a price as possible. The short holders of the contract (the sellers of the commodity) will want to secure as high a price as possible. The futures contract, however, provides a definite price certainty for both parties, which reduces the risks associated with price volatility. Hedging by means of futures contracts can also be used as a means to lock in an acceptable price margin between the cost of the raw material and the retail cost of the final product sold.

Example: A silversmith must secure a certain amount of silver in six months time for earrings and bracelets that have already been advertised in an upcoming catalog with specific prices. But what if the price of silver goes up over the next six months? Because the prices of the earrings and bracelets are already set, the extra cost of the silver can't be passed on to the retail buyer, meaning it would be passed on to the silversmith. The silversmith needs to hedge, or minimize her risk against a possible price increase in silver. How? The silversmith would enter the futures market and purchase a silver contract for settlement in six months time (let's say June) at a price of $5 per ounce. At the end of the six months, the price of silver in the cash market is actually $6 per ounce, so the silversmith benefits from the futures contract and escapes the higher price. Had the price of silver declined in the cash market, the silversmith would, in the end, have been better off without the futures contract. At the same time, however, because the silver market is very volatile, the silver maker was still sheltering himself from risk by entering into the futures contract. So that's basically what hedging is: the attempt to minimize risk as much as possible by locking in prices for future purchases and sales. Someone going long in a securities future contract now can hedge against rising equity prices in three months. If at the time of the contract's expiration the equity price has risen, the investor's contract can be closed out at the higher price. The opposite could happen as well: a hedger could go short in a contract today to hedge against declining stock prices in the future. A potato farmer would hedge against lower French fry prices, while a fast food chain would hedge against higher potato prices. A company in need of a loan in six months could hedge against rising interest rates in the future, while a coffee beanery could hedge against rising coffee bean prices next year.

Speculators

Other market participants, however, do not aim to minimize risk but rather to benefit from the inherently risky nature of the futures market. These are the speculators, and they aim to profit from the very price change that hedgers are protecting themselves against. Hedgers want to minimize their risk no matter what they're investing in, while speculators want to increase their risk and therefore maximize their profits.

In the futures market, a speculator buying a contract low in order to sell high in the future would most likely be buying that contract from a hedger selling a contract low in anticipation of declining prices in the future.

Unlike the hedger, the speculator does not actually seek to own the commodity in question. Rather, he or she will enter the market seeking profits by offsetting rising and declining prices through the buying and selling of contracts.

Trader	Short	Long
The Hedger	Secure a price now to protect against future declining prices	Secure a price now to protect against future rising prices
The Speculator	Secure a price now in anticipation of declining prices	Secure a price now in anticipation of rising prices

In a fast-paced market into which information is continuously being fed, speculators and hedgers bounce off of - and benefit from - each other. The closer it gets to the time of the contract's expiration, the more solid the information entering the market will be regarding the commodity in question. Thus, all can expect a more accurate reflection of supply and demand and the corresponding price.
Regulatory Bodies
The U.S. futures market is regulated by the Commodity Futures Trading Commission (CFTC) an independent agency of the U.S. government. The market is also subject to regulation by the National Futures Association (NFA), a self-regulatory body authorized by the U.S. Congress and subject to CFTC supervision.

A broker and/or firm must be registered with the CFTC in order to issue or buy or sell futures contracts. Futures brokers must also be registered with the NFA and the CFTC in order to conduct business. The CFTC has the power to seek criminal prosecution through the Department of Justice in cases of illegal activity, while violations against the NFA's business ethics and code of conduct can permanently bar a company or a person from dealing on the futures exchange. It is imperative for investors wanting to enter the futures market to understand these regulations and make sure that the brokers, traders or companies acting on their behalf are licensed by the CFTC.

In the unfortunate event of conflict or illegal loss, you can look to the NFA for arbitration and appeal to the CFTC for reparations. Know your rights as an investor!