Trading Futures Guide

1800-445-2000 LIND-WALDOCK.COM

TECHNICAL ANALYSIS 101 4

THE IMPORTANCE OF METHOD TRADING 7

TECHNICAL VERSUS FUNDAMENTAL ANALYSIS 9

TIPS AND RESOURCES FOR ELECTRONIC TRADERS 10

TYPES OF STOP ORDERS: A TUTORIAL 13

MOVING AVERAGES EXPLAINED 16

PIVOT-POINT TECHNIQUES 19

THE VALUE OF FAIR VALUE 21

BUILDING YOUR CME E-MINI FUTURES TRADING STRATEGY 22

THE BRILLIANCE OF GANN IN TODAYS MARKETS 24

WHEN TRENDS ARENT YOUR FRIEND: HOW TO APPROACH DRAWDOWNS 26

THE COMMITMENTS OF TRADERS REPORT: A CLUE TO WHOS MOVING MARKETS 28

INTRODUCTION TO FUTURES SPREADS 31

TRADE BY THE BOOK: A GUIDE TO READING ORDER FLOW 35

TECHNICAL ANALYSIS AND OPTIONS STRATEGIES FOR 38LONG-TERM POSITION TRADERS

UNDERSTANDING OPTIONS SPREADS 40

A MOVING AVERAGE THAT CAN MOTIVATE YOUR TRADING: TILLSONS T3 41

GLOSSARY OF TECHNICAL ANALYSIS TERMS 44

GLOSSARY OF TRADING STRATEGIES TERMS 48

GLOSSARY OF BASIC FUTURES TERMINOLOGY 53

Contents

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Professional traders know it takes an edge to successfully

navigate the marketsand for many, technical analysis provides

that edge. Technical analysis can be dened as an approach

to forecasting commodity prices that examines the patterns of

price change, rates of change, and change in volume of

trading and open interest, without regard to underlying funda-

mental market factors.

Whether its moving averages, pivot points, or Gann theory, the

study of technical analysis can provide valuable insight into price

action for virtually any market. This Guide contains a collection

of informative articles that can help you learn more. The contents

are organized by level; if youve never explored technical anal-

ysis or futures in general, the articles in Level One are the place to

start. This section also offers a refresher on concepts you may

be a bit rusty on. Level Two articles expand on the basics and offer

some additional factors you might consider. Level Three articles

are a bit more advanced, containing more sophisticated concepts

and strategies for those already familiar with technical analysis

and those who have already been trading futures.

While technical analysis methods may be the same for all traders,

your own interpretation and analysis can offer you an edge

thats uniquely yours. For that reason, technical analysis has been

called an art as much as a science. The authors of the articles

in this Guide are simply offering their interpretation of the concepts.

Advice is to be taken as educational in nature only, and not to be

construed as specic trading advice. Articles from outside authors

unafliated with Lind-Waldock have been reprinted with per-

mission. Lind-Waldock is not responsible for any advice or content

from such outside authors reproduced herein, nor from their

respective Web sites.

The Lind-Waldock Futures Technical Trading Guide

Futures trading involves substantial risk of loss and is not suitable for all investors. Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical service and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. There is no guarantee that the advice we give will result in protable trades. All trading decisions will be made by the account holder. Copyright 2007 Lind-Waldock, a division of Man Financial Inc. All Rights Reserved.


TECHNICAL ANALYSIS 101 4

THE IMPORTANCE OF METHOD TRADING 7

TECHNICAL VERSUS FUNDAMENTAL ANALYSIS 9

TIPS AND RESOURCES FOR ELECTRONIC TRADERS 10

TYPES OF STOP ORDERS: A TUTORIAL 13

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TECHNICAL TRADING 1011 2 3 G 4


There are two major types of analysis typically used to predict

the performance of commodity futuresfundamental and tech-

nical. Fundamental analysis examines the supply and demand

factors that inuence price, while technical analysis is the study of

price and price behavior. The world of technical analysis is huge

and can be applied to virtually any market. There are literally hun-

dreds of different patterns and indicators that traders claim to

have success with. In this article, Ill introduce you to a few very

basic types of price charts and technical analysis tools.

WHAT IS TECHNICAL ANALYSIS?

Using charts as a primary tool, commodity traders who employ

technical analysis look for peaks, bottoms, trends, patterns

and other factors that affect price movement, which they then use

to make buy or sell decisions. Technical analysis today includes

such principles as the trending nature of prices, prices discounting

all known information, moving averages, volume mirroring changes

in price, and the identication of support and resistance levels.

The price of a commodity represents a consensus between buy-

ers and sellers of all the information about that commodity at

any given point in time. It is the price at which one person agrees

to buy and another agrees to sell. The price at which a trader is

willing to buy or sell depends primarily on expectations.

Technical analysis reects on historical prices in an effort to de-

ermine probable future prices. This is done by comparing

current price action (i.e., current expectations) with comparable

historical price action in order to predict a reasonable out-

come. The technician might observe that history repeats itself

in price behavior because human behavior repeats itself.

Technical analysis is a method of evaluating commodities by

analyzing statistics generated by market activity, past prices, indi-

cators and volume. Technical analysts do not attempt to measure

a commoditys intrinsic value; instead they look for patterns and

indicators on the charts that will determine a future performance.

TWO BASIC CHART TYPES

Bar charts are some of the most popular charts used in technical

analysis. They display the open, close, high and low for a specied

time period. Bar charts can be used for any time frame.

The daily chart, which is the most popular time period, is often

used to study price trends for the most recent six months. For

longer-range trend analysis going back ve or 10 years, weekly and

monthly charts are more useful. Intraday charts can be used

by day traders to plot prices for periods as brief as one minute.

Each time period is a vertical line, with the top of the vertical line

indicating the highest price the commodity traded at during

the time period, and the bottom representing the lowest price.

(See Chart 1) The closing price is displayed on the right side

of the bar and the opening price is shown on the left side of the

bar. A single bar represents one time period of trading.

Candlestick charts, which have been around for hundreds of

years, are similar to bar charts in that they also display the open,

close, high and low. The primary difference is that if the closing

price is above the opening price, the body is usually clear, white or

green. If the closing price is below the opening price, the body is

usually solid, black or red. (See Chart 2)

Technical Analysis 101 BY JEFFREY FRIEDMAN

The world of technical analysis is huge and can be applied to virtually any market. There are literally hundreds of different patterns and indicators that traders claim to have success with.

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TECHNICAL TRADING 1011 2 3 G

TECHNICAL INDICATORS YOU CAN USE

A moving average is one of the easiest indicators to understand.

For example, to calculate the 50-day moving average, you

would add up the closing prices from the past 50 days and divide

them by 50. Because prices are constantly changing, the

moving average will move as well. Moving averages are most

often compared or used in conjunction with other indicators

such as Moving Average Convergence Divergence (MACD) or the

Relative Strength Index (RSI) discussed below.

While you can choose any time period you wish, the most com-

monly used moving averages are of 10, 20, 40, and 50 days.

Each moving average provides a different interpretation of what

the commodity price will do. There is no one right time frame

to use. The longer the time spans, the less sensitive the moving

average will be to daily price changes. Moving averages are

used to emphasize the direction of a trend and smooth out price

and volume uctuations (or noise) that can confuse interpre-

tation. Typically, when the price moves below its moving average

it is a bad sign because the commodity is moving on a

negative trend.

The Moving Average Convergence Divergence is one of the

simplest and most reliable indicators available. MACD uses moving

averages, which are lagging indicators, to include some trend-

following characteristics. These lagging indicators are turned

into a momentum oscillator (a measure of how much prices have

changed over a given time period) by subtracting the longer

moving average from the shorter moving average. The resulting

plot forms a line that oscillates above and below zero, without

any upper or lower limits. MACD is a centered oscillator, which

uctuates above or below a center point, and the guidelines

for using centered oscillators apply.

When we talk about the strength of a commodity futures contract,

there are a few different interpretations, one of which is the Relative

Strength Index. The RSI compares the number of days that the

contract nishes up with the number of days it nishes down. This

indicator is a big tool in momentum trading.

The RSI ranges from 0 to 100. A market is considered over-

bought around the 70 level and you should consider selling. This

number is not written in stone. In a bull market, some believe

80 is a better level to indicate an overbought price, since prices

often trade at higher valuations during bull markets. Likewise,

if the RSI approaches 30, price is considered oversold, and you

should consider buying. Again, make the adjustment to 20 in

a bear market.

The shorter the number of days used, the more volatile the RSI

is and the more often it will hit extremes. A longer-term RSI

is more rolling, uctuating a lot less. Different commodities and

futures contracts have varying threshold levels when it comes

to the RSI. Prices in some futures contracts will go as high as 75-

80 before dropping back, and others have a tough time breaking

past 70.

USING SUPPORT AND RESISTANCE

Support and resistance are price levels at which movement should

stop and reverse direction. Think of support and resistance

as levels that act as a oor or a ceiling to future price movements.

Support is a price level below the current market price, where

buying interest should be able to overcome selling pressureand

thus keep the price from going any lower. Resistance is a price

level above the current market price, where selling pressure should

be strong enough to overcome buying pressureand thus

keep the price from going any higher. (See Chart 3) One of two

things can happen when a futures contract price approaches

a support or resistance level. It can act as a reversal point, or in

other words, when the futures price drops to a support level, it

will go back up. Or, support and resistance levels can reverse roles

once they are penetrated. For example, when the market price falls

below a support level, that former support level then becomes a

resistance level when the market later trades back up to that level.

Chart 1: Bar Chart Chart 2: Candlestick Chart

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POPULAR CHARTING PATTERNS

Many of us believe that history repeats itself. Using successful

and proven price patterns from price charts is a method technical

analysts widely use.

There are entire volumes of textbooks written on technical analysis.

Its one of those elds where everyone has a different theory on

what works and what doesnt. I suggest you do some homework

and back test your desired strategy. Back testing means look-

ing back at several years worth of charts to see how a particular

futures contract reacts. Different markets do different things.

Here are just a few examples:

Cup and Handle. This is a pattern on a bar chart that can be as

short as seven days or as long as 65 days. The cup is in the shape

of a U. The handle has a slight downward drift. The right hand side

of the pattern has low trading volume. As the price comes up to

test the old highs, the price will incur selling pressure by the people

who bought at or near the old high. This selling pressure will make

the price trade sideways with a tendency towards a downtrend

for four to 30 days, and then it may take off. It looks like a pot with

handle.

Head and Shoulders. This chart formation resembles an M in

which a price rises to a peak and then declines, then rises above

the former peak and again declines, and then rises again, but not

to the second peak and again declines. The rst and third peaks

are shoulders, and the second peak forms the head. This pattern is

considered a very bearish indicator.

Double Bottom. A double bottom occurs when a price drops to

a similar price level twice within a few weeks or months produc-

ing a pattern that resembles a W. You should buy when the price

passes the highest point in the handle. In a perfect double bottom,

the second decline should normally go slightly lower than the rst

decline to create a shakeout of jittery traders. The middle point of

the W should not go into new high ground. This can be a very

bullish indicator.

Jeffrey Friedman is a Senior Market Strategist with Lind Plus. He can be reached at 866-231-7811 or via email at [email protected] for more information about this topic or others.

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Chart 3: Resistance and Support

800-445-2000 WWW.LIND-WALDOCK.COM

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In futures speculation, there are winners and losers. Some specu-

lators put themselves in positions (either because of their emotional

makeup or because of a lack of knowledge) from which they can-

not hope to emerge successfully. While their motivations may be

primarily psychological, part of their failure can be attributed to a

lack of knowledge of trading techniques.

There are many successful trading methods or plans. But, what

works for you wont necessarily work for someone else. Its very

important that you develop a method of trading that matches your

trading goals and personality, so you can protect yourself from your

own weaknesses. Without a method, you run the risk of succumb-

ing to the temptations and stresses that are constantly present in

the market.

Here are several practical rules that can be applied to any trading

system. These are rules we believe should be integrated into your

trading system, so that you have your best chance of success.

1. ADOPT A DEFINITE TRADING PLAN.

Because of the emotional stress inherent in any speculative situ-

ation, you must have a predetermined method of operation that

includes a set of rules by which you operate and to which you

rigidly adhere, in order to protect you from yourself. Very often your

emotions will tell you to do something totally foreign or negative to

your market-trading plan. If youre following a plan, theres a better

chance youll avoid knee-jerk decisions.

2. IF YOURE NOT SURE, DONT TRADE.

If youre in a trade and feel unsure of yourself, take your loss or

protect your prots with a stop. If you are unsure of a position, you

risk being inuenced by any number of extraneous and unimport-

ant details.

3. YOU SHOULD BE ABLE TO BE RIGHT 40 PERCENT OF THE

TIME AND STILL SHOW A PROFIT.

In speculating, it is unrealistic to expect to be right every time. If

you follow proper trading techniques, you should be able to cut

losses short and let prots run so that even being right less than

half the time will yield prots.

4. CUT YOUR LOSSES AND LET YOUR PROFITS RIDE.

One basic failing of speculators is that they put a limit on prots

and no limit on losses. They hate to admit being wrong, and will

often let losses ride in hopes that the market will turn around. After

a while, they begin hoping for a small loss and give up hoping for

a prot. There is an old saying, you never go broke taking a small

prot...but youll certainly never get rich that way.

Small prots are the direct opposite of the best way of making

money in speculation. If you are correct when entering a specula-

tive situation, you will know it almost immediately and will show

a prot. However, if you are wrong, you will show a loss and you

should remove yourself from the situation as quickly as possible.

Taking a small loss does not necessarily mean your thinking was

wrong. It simply means that your timing was perhaps incorrect and

that you should wait for the correct timing and situation to allow

you to reenter the market.

Remember, in any speculative situation, the market is the nal

judge. You must let the market tell you when you are wrong and

when you are right. If you show a prot, ride it until the market turns

around and tells you that you are no longer right. Then get out, but

not before! On the other hand, the market will also tell you if you are

wrong, and it is a serious mistake to argue with the market.

The Importance of Method Trading BY LIND-WALDOCK

Its very important that you develop a method of trading that matches your trading goals and personality, so you can protect yourself from your own weaknesses. Without a method, you run the risk of succumbing to the temptations and stresses that are constantly present in the market.


THE IMPORTANCE OF METHOD TRADINGi


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5. IF YOU CANNOT AFFORD TO LOSE, YOU

CANNOT AFFORD TO WIN.

Losing is a natural part of trading. If you are not in a position to ac-

cept losses, either psychologically or nancially, you have no busi-

ness trading. In addition, trading should be done only with surplus

funds that are not vital to daily expenses.

6. DONT TRADE TOO MANY MARKETS.

Its difcult enough to successfully trade and understand a specic

market. Its next to impossible for an individual, especially a begin-

ner, to be successful in several markets at the same time. The

fundamental, technical and psychological information necessary

to trade successfully in more than a few markets is more than you

probably have the time or ability to manage.

7. DONT TRADE IN A MARKET THAT IS TOO THIN.

A lack of public participation in a market will make it difcult, if

not impossible, to liquidate a position at anywhere near the price

you want.

8. BE AWARE OF THE TREND.

It is vitally important that you are aware of a strong force in the mar-

ket, either bullish or bearish. When this force is at its height it would

be folly to attempt to buck it; however, you must learn to recognize

when a trend is about to run its course, or is near exhaustion. This

will help you protect yourself from staying in the market too long,

and youll be able to change direction when the trend changes.

9. DONT ATTEMPT TO BUY THE BOTTOM OR SELL THE TOP.

It simply cant be done unless you have the aid of a crystal ball. Be

content to wait for the trend to develop and then take advantage of

it once it has been established.

10. NEVER ANSWER A MARGIN CALL.

This rule serves as a stop loss when your position has weakened

considerably. If you follow this rule, you will be forced to get out

of the market before total disaster sets in. It is often difcult to

admit youre wrong and get out of the market (which you probably

should have done well before you received a margin call).

However, the presence of a margin call should act as a clear and

nal warning that you have let your position go as far as you

conceivably can (unless the initial margin is out of line with the

volatility of the contract).

11. YOU CAN ALWAYS SELL THE FIRST RALLY OR

BUY THE FIRST BREAK.

Generally, a market that has just established a trend (either up or

down) will have a reaction. Good interim prots can be made

by recognizing this reaction and taking advantage of it. For ex-

ample, in a bull market, the rst reaction will generally be met

by investors waiting to buy the break. This support generally

causes the market to rally. The reverse is true of a bear market.

12. NEVER, EVER STRADDLE A LOSS.

A loss by itself is difcult enough to accept; however, to lock in this

loss, making it necessary for you to be right twice rather than once,

which you previously found impossible, is sheer absurdity.

All of these rules are part of a common sense approach to making

trading decisions that will help you manage your performance. In

fact, youll nd that if you dont follow a trading method, youll never

know what to credit your results to. If you follow a set of rules, youll

be able to diagnose your setbacks and successes, evaluate the

quality of your rules and determine whether you have actually been

following them with discipline.

Whatever method you apply, just be sure it ts your comfort levels

for style, performance and risk tolerance.

THE IMPORTANCE OF METHOD TRADINGi

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Technical Versus Fundamental Analysis BY STUART KAUFMAN

The debate between fundamental and technical analysis has raged for decades. It is important to clarify the difference.


Fundamental Considerations

Economic factors

Supply and demand

Market-specic data

Technical Considerations

Price action

Chart patterns

Volume and open interest

I am often asked what are the differences between fundamental

and technical analysis, and how do I decide which to use when

I trade.

The debate between fundamental and technical analysis has raged

for decades. It is important to clarify the difference. By denition,

fundamentals consist of the economic factors behind a commod-

ity, namely the inuences on supply and demand. For example,

fundamentals of cotton would include the size of last years crop,

the amount of cotton left from that harvest that is still available for

export and domestic use, the pace of exports this year, the prog-

ress of the upcoming crop, and projected weather that could affect

its growth. These are all fundamentals, and if it looks like a lot of

information, it is.

Assuming that one is able to monitor all these factors, the next task

is to form a big picture of the market and then try to determine

how these factors could affect price over the next three to six

months. Doing this is a key task in selecting markets that provide

the greatest opportunities for prot.

Technical analysis, on the other hand, is the study of charts, chart

formations, and an array of technical indicators that affect volume,

price momentum, strength of buying or selling, and so on. Because

technical trading tends to be more concrete and tangible (e.g., buy

when prices hit this line), it attracts both the mathematical and the

statistical-oriented crowds. Pure technicians believe all the cur-

rent fundamentals are always priced into a futures contract at any

given time. Therefore, there is no use in studying the fundamentals

because they are all reected in the price patterns.

I think that may be true to a certain extent. Most of the known

fundamentals could be reected in the current price, because

fundamental knowledge often lags technical indications of a price

move. What the pure technicians overlook is that studying funda-

mentals is not done to determine how they are impacting the price

today, but rather to project how these factors could impact prices

in the future.

My opinion is that its important to be cognizant of both kinds of

analysis, but that technical analysis tends to get you in the market

quicker and at better price levels.

Stuart Kaufman is a Senior Market Strategist at Lind Plus. If you would like more information about this topic or others, you can contact him at 800-924-1060 or via email at [email protected].

TECHNICAL VERSUS FUNDAMENTAL ANALYSISi

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Whether you are learning to trade online for the rst time or are

looking to improve your current online trading skills, nding the right

resources and the right support can be critical to your success. As

the old saying goes, no man is an island. As a self-directed trader

making your own decisions, you may at times feel like you are on

an island all alone. But there are plenty of resources to help you

gain condence. What you need and where you will get it depends

to a great extent on the type of trader you want to be, the trading

style you believe will be most suited to your personality, and the

amount of money and time you have to devote to trading.

The type of trader you choose to be will have some bearing on the

resources you needwhether you plan to trade via technical or

fundamental factors, what markets you plan to trade, and whether

you plan to day-trade or hold longer-term positions. Years ago all

you might have needed to trade was a phone and an idea, but in

todays technological era, a personal computer and an Internet

connection to link you to the marketplace are essentialalong with

telephone service as a backup.

TRADING PLATFORM

Selecting a trading platform is an important rst step as you learn

to trade online because you may want to not only enter your or-

ders, but also do your own analysis. There are several aspects of a

platform to consider.

Type of Platform. Do you want a downloadable version that high-

lights speed and accuracy? Do you want a browser-based plat-

form? What about wireless trading? The Internet can be a rather

fragile network and may not always be the most reliable means of

conveying your orders, especially during critical periods when tim-

ing is most important.

If there is some disruption in your online connection, you need

access to a means of live technical support to assist you with any

questions.

Ease of Use. The platform should be simple to understand and

operate to facilitate transmission of orders quickly. If you are an

active trader or plan to be, you want to see market depth, which is

the listing of a markets most recent bids and offers. Check to see

if you can place an order from the market-depth screen. Custom-

ization is another important feature. What data do you want to see

when youre trading?

If you are looking at a chart or price quote, a platform may formu-

late the order for you so all you have to do is click buy or sell.

Procedures to enter an order should be clear and easy, yet should

have enough safeguards to reduce your chances of making mis-

takes as you make your trades.

Market Access. You will likely want a trading platform that has

the most exibility to trade a wide variety of markets. At a later

date, you may want to add a new market you arent interested in

trading right now, so look at the big picture. Find out which global

exchanges your rm is connected to. New, attractive contracts are

being established all the time all over the world. If you see a trading

opportunity on an overseas exchange, your broker should be able

to facilitate trading in those markets.

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

to trade online, get comfortable with a trading platform, or to test

a trading system is simulated trading. Everything about the trading

is real except that you use virtual money instead of real money.

Although it cannot match the emotional involvement real trading

does, simulated trading helps you learn the mechanics of trading

Tips and Resources for Electronic Traders BY DAVE HOWE

What you need and where you will get it depends to a great extent on the type of trader you want to be, the trading style you believe will be most suited to your personality, and the amount of money and time you have to devote to trading.


TIPS AND RESOURCES FOR ELECTRONIC TRADERSi

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and become familiar with the trading platform before you have to

deal with the pressure of trading real money. Depending on your

knowledge of trading and skill level, it is like using a simulator to

learn how to y an airplane or drive a car before being placed in

realand possibly dangeroussituations. You enter trades, get

lls, receive account statements, etc. just as a real trader does and

can learn from your mistakes without having to pay real money to

gain the experience.

TRADING SUPPORT TOOLS

If you are going to take your trading seriously, you will need more

than just a way to enter orders and track your account. There are

other resources you will likely need.

Price Quotes. To keep up with the current market status, you will

probably need some type of price quotes updated on a regular

basis. How much data you need and how often you get it will

depend on the type of trader you are and the amount of money

you are willing to spend. Real-time streaming quotes are up-to-the-

second prices updated continuously by the exchanges. They may

be reported tick-by-tick or only when there is a change in prices,

depending on the quote service. Based on your level of trading

activity, these quotes usually involve monthly exchange fees. If

you want to be an active intraday trader, you will probably need

real-time quotes. In some cases, exchanges offer real-time quotes

at no charge to encourage trading in a market, typically for a new

contract or for an area that the exchange is promoting.

Real-time delayed quotes provide the same information as real-

time quotes, but are delayed by 10 to 30 minutes. If you are a

highly active day-trader, this time lag probably wont be acceptable.

However, if your approach is longer-term in nature and doesnt

require trading decisions be made down to the second, delayed

quotes may be sufcient. Delayed quotes will also save you some

money as well, as they currently do not have exchange fees.

Snapshot quotes are live quotes but are available on a refresh

basis only every 10 minutes or so. Like delayed quotes, snapshot

quotes may be all you need if your trades are not highly time sensi-

tive. End-of-day quotes provide the open, high, low, and closing

prices for each day. This is a basic quote service used for some

trading systems that provide only one signal based on a days trad-

ing activity.

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

of a market during different time horizons. Charts allow traders to

study what the market has done in the past in similar situations, so

they can attempt to discover trading signals and projected targets

based on what their analysis suggests for the future. The study

of technical analysis is based on interpretation of various chart

patterns, and can be very complex. It is often considered an art as

much as a science.

Analytical Software. Analytical software provides a wide array of

charts as well as a number of studies and technical indicators, and

perhaps even some means to test the performance of a trading

method you develop. The studies generally range from simple mov-

ing averages to a series of momentum indicators such as stochas-

tics or relative strength. Many are based on the same inputprice

so there is a danger of putting too much weight on signals that

are similar. System-testing capability gives you an opportunity to

try out ideas in market situations without having to use real money

to test a theory.

News, Reports, Statistics. Although market technicians would

say prices respond to signals on charts, the underlying force for

any signicant market movement comes from fundamentals such

as supply and demand. Often, these are revealed in government

reports and statistics that have scheduled release dates. You need

to be aware of these key dates and the numbers other traders and

market analysts are forecasting to help you determine how the

market might react to them.

An unexpected event can also cause extreme price uctuations,

especially in the short-term. You need to have a news source that

can keep you apprised of these events in a timely manner so you

can analyze how you might want to position yourselfor perhaps

more important, not position yourselfin a volatile market environ-

ment. By the time you read about a market-moving event in the

newspaper, it may be too late, and television news reports may be

too brief and shallow to help you as a trader, assuming the event

has caught the news departments attention to even be mentioned.

News services that can provide key market-moving information are

available online and may be provided by your broker or as an add-

on service for a fee. Like price quotes, the cost usually depends

on whether you receive the news reports real-time or delayed, and

whether you need a specialized service that covers a particular

market in depth.


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

OTHER EDUCATIONAL RESOURCES

As a self-directed trader, you want to take advantage of all the

resources you can. Here at Lind-Waldock, we offer many means of

educational support, including online courses and articles via

our Web site, timely trading ideas from Lind Plus brokers in our free

weekly Markets on the Move webinars, as well as our monthly

Lind eWire newsletter.

As a self-directed trader, you may not need anyone elses advice

on what or how to trade. Even if you dont plan to use anyone

elses recommendations, it can be helpful to listen to what a broker

or analyst is suggesting for several reasons. It can help you under-

stand what other traders are thinking and how they might be react-

ing to the same type of market developments you are watching.

You can compare someone elses trading decisions with your own.

You may even take a recommended trade because the analyst who

presented it has probably done more research, considered more

inputs than you have, and has formed a good case for making the

recommendation.

An essential resource for one trader may be impractical for you.

The key point is not to accumulate resources, but to nd those that

can help you most as a trader. And that is for you to decide!

Dave Howe is Director of Sales with Lind-Waldock. He can be reached at 800-445-2000 or via email at [email protected] for more information about this topic or others.


1 2 3 G 13

There is no surere way to eliminate risk in any investment, but

nding ways to alleviate as much of it as you can is vital. Stops

can be a valuable tool in your risk-control strategy and allow you to

execute your trading plan without the stress of constant market-

monitoring. Here we take a look at what stops are, and how to

use them.

STOP ORDERS AS LOSS-LIMITING ORDERS

Commonly referred to as a stop loss, stops are often used as loss-

limiting orders. You indicate that you want to get out of the market

at a specied target price level if the market trades at or through

that price. Buy stops are placed above the market and become

market orders if the market trades or is bid at or above your stop

price. Sell stops are stops placed below the market and become

market orders if the market trades or is offered at or below your

stop price. Its important to note that there is no guarantee that

losses will be limited to the desired amount. There can be market

gaps, or dramatic price movements that result in losses substan-

tially higher than the amount targeted with the stop-loss order. The

market has traded through your pricebut perhaps much farther

and faster than you had planned.

STOP ORDERS AS PROFIT-PROTECTION VEHICLES

Although stops are most commonly used to exit a losing position,

they can also be used to protect prots or to enter positions as

markets move into territory considered a favorable entry point. This

can help you execute trades at desired levels automatically. Keep

in mind, although stops become market orders when elected, they

can be subject to whats known as slippage. Slippage occurs in

fast-moving markets when stops are lled at prices worse than the

stop price. In addition, in markets with price limits in effect during

highly explosive periods, stops may be unable to be lled. A stop

placed as an open order, known as GTC, short for Good Until

Cancelled, may be unable to be lled for several consecutive ses-

sions if the market is in a limit-up or limit-down situation, but will be

lled at the rst available opportunity.

An open order is good until cancelled or lled, or until the prod-

uct goes off the board; that is, the contract has expired and is no

longer available for trading. A day order is good only for the regular

trading session during which it is placed, or for the next session

if placed in between sessions. All orders are assumed to be day

orders unless otherwise specied.

DIFFERENT TYPES OF STOP ORDERS

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

stop price when the market trades or is bid at or above the stop

price. A sell-stop limit becomes a limit order at the stop price when

the market trades or is offered at or below the stop price. The

stop and limit are the same price. These orders are designed to

eliminate slippage on stops. However, they may come back un-

able, which simply means they are not able to be lled, and cannot

be considered as protection in fast-moving markets. This is not a

common order type in open-outcry markets, but may be almost a

necessity on some electronic markets that are not very liquid.

Stop With Limit (STWL). This order type is similar to a stop limit in

that a limit price is established. However, the limit on a stop with

limit is different from the stop price, and provides some allowance

of slippage. Once the stop is elected, the order works as a limit

order, and as is the case with the stop-limit order, may come back

unable. Therefore, it cannot be considered as protection in fast-

moving markets. Although created for use in open-outcry trading,

these orders are most functional on electronic platforms that ac-

cept them. This order is useful when you want to place limit orders

slightly above the market on buys and slightly below the market

on sells. The additional room to ll the order may eliminate missed

market opportunities. However, its recommended you check with

your broker before using this order type actively.

Types of Stop Orders: A Tutorial BY KRISTINA ZURLA LANDGRAF

Stops can be a valuable tool in your risk-control strategy and allow you to execute your trading plan without the stress of constant market-monitoring. Here we take a look at what stops are, and how to use them.


TYPES OF STOP ORDERS: A TUTORIALi

14


1 2 3 G

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

able if the days closing range is at or through your stop price.

There is no reference point to determine if this is a good order

and, as such, it can be placed at any price within the days

allowable range. If the market has no limit, there are no such

restrictions within reason. You would use an SCO when you

do not want a stop order to be activated during the session but

do want it to be activated if the market trades at your stop-

order level during the closing price range. This order helps you

avoid being taken out of a position on a stop that might be

hit during intraday price uctuations.

Of course, there are many other types of orders you can place

and strategies you can use to help you manage your trading risk

while executing your plan. We encourage you to work with a

Lind Plus market strategist to nd out more. The Education Tab on

our Web site also contains more information on order types.

Kristina Zurla Landgraf is Content Manager at Lind-Waldock.

TYPES OF STOP ORDERS: A TUTORIALi


MOVING AVERAGES EXPLAINED 16

PIVOT-POINT TECHNIQUES 19

THE VALUE OF FAIR VALUE 21

BUILDING YOUR CME E-MINI FUTURES TRADING STRATEGY 22

THE BRILLIANCE OF GANN IN TODAYS MARKETS 24

WHEN TRENDS ARENT YOUR FRIEND: HOW TO APPROACH DRAWDOWNS 26

THE COMMITMENTS OF TRADERS REPORT: A CLUE TO WHOS MOVING MARKETS 28

1 2 3 Gi

3 G 16


Moving Averages Explained BY DAVE HOWE

A moving average smooths out temporary price uctuations and can help give you a clearer interpretation of which direction the market is moving.

I expect youve heard the term moving average. And, I expect

you may have wondered what it is, or how to use it. This article is

intended to answer both of these questions, and add to your

trading knowledge.

Simply put, a moving average is the average value of a commodity

or futures contracts price over a specic period of time. Moving

averages come in different forms. Two of the more common are:

The Simple Moving Average (SMA) and the Exponential Moving

Average (EMA).

Now that you have the denition of a moving average, lets consider

the question, Why would you want to use a moving average?

Its very simple. A moving average smooths out temporary price

uctuations and can help give you a clearer interpretation of

which direction the market is moving.

The use of short-term and long-term moving averages is really

a matter of personal preference. Short-term moving averages tend

to be very sensitive to price movements, whereas the long-term

moving averages are less sensitive to these same movements.

Take a closer look at the two we are discussing.

SIMPLE MOVING AVERAGES

Well begin with the simple moving average. We said that a moving

average is gured by averaging the price over a selected time

period. Lets say you have selected a 10-period, sometimes called

a 10-bar moving average for the June S&P 500. To nd this moving

average, you add together closing prices of the June S&P 500 for

each of the last 10 periods and then divide the total by the number

of periodsin this case 10. With each new period, you drop the

oldest closing price and replace it with the new one. The result is

the moving average for the last 10 periods.

Notice that in the example, we did not say 10-minute or 10-day

moving average, we said 10-period moving average. This is im-

portant because the type of moving average you choose will work

differently across different time frames. A 10-bar moving average

is the same calculation whether you are working from 5-minute bar

charts or end-of-day charts. The periods of time are different. With

the 5-minute bar chart, you are calculating the moving average

based on the average closing prices of 10 5-minute periods. With

the end-of-day charts, you are calculating the moving average

based on the average closing prices of 10 daily periods.

As we mentioned before, you can choose to use these moving

averages on different types of charts. You are not limited to 5-min-

ute or daily. Traders use many different types of charts. Examples

might be 1-minute, 5-minute, 30-minute, 60-minute, daily, weekly

and even monthly.

Its worth noting one more time that moving averages can be cal-

culated for any given period of time. Day traders and other short-

term traders may wish to use a moving average based on minutes

rather than days. For instance, if you are planning to trade the

market, trying for small intraday prots, you might use 5-minute bar

charts. In this case instead of using the closing price for the day,

you are using the closing price for the last 5-minute period of time.

Typically, the most common or standard moving averages for trad-

ers are the 4-, 9- and 18-period moving averages, but again, any

time period could be selected.

When reading a chart, moving averages show up as an unbroken

line making it easier to see the trend of the market. The chart

on the following page illustrates a daily bar chart. In this case, we

chose a less conventional 10-bar and a 30-bar moving average of

the June 2004 S&P 500 futures contract.

When the 30-bar moving average makes a signicant turn or bend,

it has more credibility as an indicator of change in the direction

of the overall trend than does the 10-bar. You see fewer false

changes in direction using a longer period moving average than the

shorter period. Conversely, the shorter period moving average,

being more sensitive, will at times give you an earlier indication of

change indirection.

MOVING AVERAGES EXPLAINED21i

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Exponential Moving Average Formula

Step 1.

K = 2 / (1+N)

Step 2.

X = (K x (C - P) + P

EXPONENTIAL MOVING AVERAGES

One of the drawbacks of the moving average is that it is a lagging

indicator. You can only see what happened in the past. To help

compensate for that, traders constructed the Exponential Moving

Average. The exponential moving average gives more weight to

the most recent data, hopefully giving an even more timely indica-

tion of market direction.

In the exponential moving average, or exponentially weighted mov-

ing average, the amount of weight given to the earlier data is de-

pendent upon the length of the moving average used. For example,

the shorter length moving average (i.e., a 3-, 4-, or 9-period) gives

a higher weight to the more recent data than the longer length

moving average (i.e., the 10-, 18-, or 30-period).

This makes the shorter-period moving averages react more quickly

to recent data than the longer-period moving averages.

To calculate the exponential moving average, you apply a smooth-

ing constant to the equation. The smoothing constant (K) is derived

by dividing the number 2 by 1 plus the number of periods in the

moving average (N).

Once you have the smoothing constant (K), you can calculate the

rest of the moving average. First, you subtract the previous periods

EMA (P) from the current price (C) and multiply the difference by

the smoothing constant (K). Finally, you add back the previous

periods EMA (P) to get the new EMA.

It is important to note, that when calculating the moving average for

the very rst time, you will not have an exponential moving aver-

age, so youll need to use the simple moving average for the rst

calculation and the EMA thereafter.

MOVING AVERAGES EXPLAINED21i

Daily Bar Chart: June 2004 S&P 500

18


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HOW TO USE THEM

There are a number of different ways to use moving averages.

Many traders choose to combine a short-term moving average

with a longer-term moving average. Generally when the short-term

moving average crosses over the longer-term, this is considered

contrary to the longer-term trend. This indicator is called

a Crossover.

Others choose to create a band or Envelope around the moving

average by drawing parallel lines both above and below the moving

average line. These parallel lines are set at a percentage away from

the line, which indicates the normal distance the price will move

above or below the average before gravitating back towards the

moving average line. The general feeling is that if a market trades

through one of these outside bands it is a very strong indicator of

future direction of the market.

These are just a few examples. What youve learned here is just

the tip of the iceberg as it relates to moving averages, and for that

matter all technical analysis. Most traders begin by learning the

basics, combining and adding additional indicators, lters and rules

into the mix resulting in a complete trading methodology. Your next

step should be the discovery of these additional tools. A great way

to get started on your education is to visit our education site at

www.lind-waldock.com/edu.

If youd like help, Lind-Waldock has a team of market strategists

who are happy to help you get a jump-start on your education. Feel

free to call us at 800-445-2000, and well pair you up with a

mentor to help guide you.

Dave Howe is Director of Sales with Lind-Waldock. He can be reached at 800-445-2000 or via email at [email protected] for more information about this topic or others.

1 2i

MOVING AVERAGES EXPLAINED

3 G 19


Pivot-Point Techniques BY JEFFREY FRIEDMAN

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

PREDICTING PRICES USING SUPPORT AND

RESISTANCE POINTS

Support and resistance (SAR) are rst and foremost the most

important points to watch in price chart patterns. Finding rst and

second support points (S#1 & S#2) and rst and second resistance

points (R#1 & R#2) can help you predict how far prices might climb

and how far they might fall before you trade. Lets nd out how

support and resistance works and how to use pivot points.

DEFINING SUPPORT AND RESISTANCE

Support occurs when increased demand for a particular futures

market builds a oor under that markets price. A support level or

zone appears when buyers miss purchasing a futures contract and

vow to buy it later should prices decline to the same, or nearly the

same, level.

Resistance occurs when selling pressure stops a markets price

rise. A resistance level is similar in that traders buy the futures con-

tract just before it tumbles and they vow to sell if its price reaches

their purchase price. A common mantra among novice traders is,

as soon as I get my money back, Im selling. SAR comes in many

avors, and well discuss the most important one to us: pivots.

PLAYING THE PIVOT

Pivot points sound like they could be critical junctures in the mar-

ket, and for some active traders looking at intraday charts, they are.

In fact, just because these traders look at pivot points and respect

them may be exactly the reason they often work. That is, they may

be a self-fullling prophecy because so many traders know about

them and trade or fade the same numbers.

A price bar represents all the prices traded in a specic time frame

for a particular market, and a pivot point is a computed number

based on a price bars high, low and close. From it, support and

resistance levels are calculated that act as sort of a bracket for the

next price bars action.

USING PIVOTS FOR SUPPORT AND RESISTANCE

Pivot levels show support and resistance points that can be used

for day trading or swing trading. Day trades are those that last

for less than one day, while swing trades last between one and

ve days.

A special mathematical formula calculates three numbers using

the high, low and closing price data with volatility, which shows

momentum. These numbers come from a proprietary formula.

PIVOT POINT TECHNIQUES21i

Chart 1: Suupport and Up Trend

Chart 2: Candles Support Trend

20


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The basic pivot technique involves trading with support and resis-

tance levels derived from the previous days or weeks (what ever

time period you want to use) high, low and closing prices. The idea

is to sell when price violates these levels on a break and buy when

price pushes through them on the upside.

Because former resistance becomes future support and vice

versa, these levels provide key stop-loss levels. For example, if you

sold when the market broke through support level one, you would

immediately place your stop at or just above the support level one

price. If the price continues to drop, you can follow the market with

a trailing stop. Although these levels sometimes will provide valid

support and resistance levels throughout the time period you use,

their signicance diminishes as they are repeatedly violated. The

rst time is the most important.

So, what do you have when you apply pivot-point lines to your

chart? Active traders treat them like support and resistance levels,

acting as potential boundaries for the next bars price range. Or, if

prices do break through S#1 or R#1, a stop might catch a move to

the next target, the S#2 or R#2 line. The support and resistance

lines may turn back prices because thats as far as market strength

or weakness can take them or because so many traders expect

that to happen, but these lines arent walls. What may be more

important is how prices react as they approach or break through

these lines. When prices are attacking the R#1 and R#2 resistance

lines consistently, the bullish trend is entrenched; when prices back

away from the R#1 and R#2 lines, the bullish trend is weaken-

ing. Like many things about price charts, pivot-point analysis isnt

perfect. It helps if the pivot-point lines coincide with prior highs or

lows, chart patterns, candlestick analysis or other corroborating

evidence. However, pivot points can be another effective trading

tool for your arsenal.

Jeffrey Friedman is a Senior Market Strategist with Lind Plus. He can be reached at 866-231-7811 or via email at [email protected].

PIVOT POINT TECHNIQUES21i

Chart 3: Silver Pivot Point

Pivot Table: April 3-7, 2006

Commodity High Low Close R1 R2 Pivot S1 S2

SPM6 1319.00 1300.50 1303.30 1314.70 1326.10 1307.60 1296.20 1289.10

US$M6 90.08 88.96 89.39 89.99 90.60 89.48 88.87 8836

DJM6 11365 11162 11195 11319 11444 11241 11116 11038

NQM6 1737.50 1683.00 1720.00 1744.00 1768.00 1713.50 1689.50 1659.00

3 G 21


Savvy traders use every piece of market information to their advan-

tage. Fair value may be one piece of information youve overlooked,

but it can enhance your stock index futures trading strategy if you

do a little homework.

Youve probably heard about fair value, but what is it, and how

can it enhance your trading? Simply put, fair value shows the

relationship between a stock index futures contract and the under-

lying cash stock index. Its a tool that can help traders determine

whether the futures market may be over- or under-priced in relation

to the cash market.

Lind-Waldock calculates fair value daily for clients on our Web site

(using three different interest rates) for the front three months of

the Standard & Poors 500 Index and the Dow Jones Industrial

Average. Go to the Trading Tools tab at www.lind-waldock.com for

detailed calculations.

Fair value, or fair basis, shows how far the futures contract should

be trading above or below the cash index given expected dividend

income for the stocks in the cash index, the days to expiration for

the futures contract and the short-term interest rate. If the futures

price moves far above or below the fair value premium band, index

arbitragers typically will execute trades which will bring the cash

and the futures prices back into line.

Fair value refers to the spread between the index futures and cash

index price, or where futures should be fairly priced. To most of

the large institutional traders, when the spread is at fair value, own-

ing stock index futures or individual equities that make up the cash

index doesnt make much difference. However, when the spread

between the index futures and cash index falls below fair value

or moves above it by a large enough margin, then one alternative

(stocks or futures) will become more attractive than the other, and

they will sell one and buy the other. If futures are sharply above fair

value, market participants are expecting the cash index to move

higher, and if they are below, lower.

Thats information you can use.

In general, fair value works as a lter, said Dave Lerman, associ-

ate director, index products at the Chicago Mercantile Exchange.

If the S&P futures are supposed to be trading at a 0.6-point

discount (to the cash), and you are buying at one-point premium, it

will negatively impact your execution and take away your prot po-

tential, he said. Lerman noted one pitfall traders should avoid

putting in orders too soon when they see the futures well above

or below fair value. If you see this happening, chances are, so will

others. The big arbitrage players will move at lightening speed to

help cause the markets to move back in line. If you see futures

are rich, wait a few seconds until fair value reasserts itself, then go

ahead and buy, he said.

The concept of fair value isnt just valid for the markets opening;

once you make your basis calculation of what fair value should

be, its good all day, barring any extreme interest rate or dividend

uctuations.

Even if you dont plan to use fair value in your trading strategy,

traders should be aware of fair value for another important reason.

All domestic stock index futures products at the CME are settled to

fair value at the end of every month. This is to alleviate any track-

ing error associated with the fact futures markets are open 15

minutes later than the cash stock markets. So if you have a posi-

tion on at month-end in these markets, youll want to know where

you stand.

Kristina Zurla Landgraf is Content Manager at Lind-Waldock.

The Value of Fair Value BY KRISTINA ZURLA LANDGRAF

Simply put, fair value shows the relationship between a stock index futures contract and the underlying cash stock index. Its a tool that can help traders determine whether the futures market may be over- or under-priced in relation to the cash market.

THE VALUE OF FAIR VALUE21i

3 G 22


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

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

Dan Gramza, president of Gramza Capital Management, discusses

the basics of CME E-mini futures trading and how to develop your

own trading strategy for any market using popular technical analy-

sis methods. View a full online presentation, by Dan, co-sponsored

by CME, in our Events area archives at www.lind-waldock.com.

Its free to view and illustrates the concepts presented here and

others in more detail. Following is a summarized excerpt from his

presentation, edited by Lind-Waldock.

CMEs popular E-mini index futures trade more than a million

contracts per day. Why is this important? And why are E-minis at-

tractive products?

Liquidity. The marketplace in general has accepted this market.

Traders like you and me, private traders, institutional traders and

investors, are now participating in this market worldwide. It means

you and I can enter and exit our trades easily (liquidity). It means a

tight bid/ask spread, which is going to reduce our cost of trading.

Capital Efciency. Dont let the name E-mini fool you, each con-

tract controls thousands of dollars of stock. In fact, the only thing

that is mini about these markets, is the capital required to trade

them. Compared to stocks or ETFs (exchange traded funds), you

only have to put up a fraction of the amount of margin.

Virtually 24-Hour Trading. Virtually 24-hour trading is one of the

things I nd attractive about this product. It means you can express

your opinion about our stock market even when the stock market is

not open. We also see those opinions expressed around the world,

from Asia to Europe.

Central Marketplace. Also, I think an advantage of this market-

place is that its oneone central marketplacethe CME. If I trade

stocks, they can trade on the American Stock Exchange, the New

York Stock Exchange, or regional exchanges.

Other Advantages. There are tax advantages to trading futures

contracts. There is no margin interest. There is no inventory

required for short positions, and there is no payment of short posi-

tion interest.

TYPES OF TRADING

Determining your trading time frame is an important element in de-

termining your trading strategy. We have four possible time frames.

Scalping. Looking at a tick or two in terms of a trade.

Day Trading. Exiting positions before the end of a session.

Swing Trading. Holding a position from one to 10 days.

Position Trading. Holding a position longer than 10 days.

These elements, these time frames, are important. They create de-

mands. If you are a scalper or day trader, your technology require-

ments are going to be very high. You have to make sure you have

accurate, up-to-date, up-to-the-second information. Where you get

in and where you get out of a trade as a scalper and day-trader is

essential in terms of your success. And, do you want to sit behind

a screen during the day? If you have the time to do that, day trad-

ing might be appropriate for you. But if you work another position

(job), it might not be appropriate.

SELECTING A TRADING TECHNIQUE:

JAPANESE CANDLESTICK

A Japanese candlestick chart uses four prices: the open, the high,

the low and the close. A box is drawn between the open and the

close. If that box is white, it means the closing price is higher than

the opening price. If the box is dark, it means the closing price

is lower than the opening price. Instead of calling it a box, the tradi-

tional term is the body of the candle. If its a white body, that

means its a buying body; it represents buying behavior coming

into the market. It its a dark body, it represents selling behavior

coming into the market. Also, you and I know the open and the

BUILDING YOUR CME E-MINI FUTURES TRADING STRATEGY21i

23


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close, and the high and the low, dont always match upthat

difference between the open and the close, the high and the low,

will be represented by a vertical line. That vertical line is called

a shadow.

Pay attention to the size, pay attention to the body color, pay at-

tention to the body size, pay attention to the shadows. Do you see

shadows on the top or bottom? And how big are they? They all

give us a measure of the degree of the buying or selling coming

into the market. When you look at a candle chart, you want to take

it apart.

SELECTING A TRADING TECHNIQUE: STOCHASTICS

Stochastics is a study, a measure of market momentum. It indi-

cates when prices have gotten high enough to attract sellers, and

it also indicates when prices have gotten low enough to attract

buyers. The underlying theme, the concept behind this, is that

its based on the premise that as prices trend higher, the closing

prices have the tendency to close near the highs. And when prices

trend lower, the closing prices have the tendency to close near the

lows. Normally displayed below a price chart, youll see a sto-

chastics scale that goes from 0 to 100. It is supposed to measure

stretchiness in the market. We use 70 and 30 as guidelines. If

this indicator trades above 70, that means its getting potentially

stretched to the upside. The term used is overbought. If its trad-

ing below 30, instead of saying stretched to the downside wed

say oversold. These indicators make up two signal lines. A sell

signal occurs when the two signal lines move above 70 and cross

over, or if the two lines move below 30 and cross over, that would

be a buy signal.

COMBINING TECHNIQUES TO CREATE A TRADING STRATEGY

Lets take these two techniques and create a trading strategy. We

are going to enter a trade if two conditions are met. First, we are

going to buy a higher high of a Japanese candle rejection pattern.

What I mean by a rejection pattern is a small body, with a large

shadow in the body. The second condition that needs to be met

is that the stochastics signal is below 30 and crossing over. If we

have that crossover below 30, and we have a Japanese candle

rejection pattern, we are going to buy a new high of that particular

candle. Our exit for this trade is that we are also going to trail our

stop below the lows of the following candles. And in this case, we

are going to stay in the trade until we trade the lower low for more

than three ticks.

There are some critical questions you need to ask when develop-

ing your trading strategy. One is your prot objective. How do I

determine my prot expectations for this trade? We are going to do

some research, thats how we get answers. Find out, if I did this

trade every time in the past, what the range of my prots might be.

What was the minimum to the maximum? I put my prot expecta-

tions in line with what the market can give me.

And, how much do I have to risk? How much heat should I take

in this trade? Take a look at protable trades, and break them into

categories. Calculate a heat index. Heat is based on volatility

and trading characteristics of the market. So, if you have an idea

of how much heat you are going to take, and how much prot you

can (potentially) make, you have to decide if these balance out. Is

the risk/reward appropriate? What are the chances of this trade not

working? What is the probability this trade will be protable?

Its also important to think about other factors, such as trade dura-

tion, and trade frequency. How patient should I be? How often can

I expect to see this trade? Is it stable in different trading environ-

ments, a trending market or a sideways market? Can we consis-

tently take something away from this market, or do we see some

weaknesses? In a downtrending market, maybe it doesnt work

so well. We want to identify that. We want to know, is this trading

strategy robust? We dont want to ask something from a trading

strategy it cant give us.

EVALUATE YOUR STRENGTHS AND WEAKNESSES

A part of our trading strategy process is the trading decision pro-

cess we go through. Lets think about what we do when it comes

to putting on a trade. The rst thing we have to do is identify the

trade, the second thing we have to do is evaluate the trade, the

third thing we have to do is execute the trade, and the fourth thing

we have to do is manage the trade. We have to manage it from a

prot and loss perspective, and we also have to manage our-

selves. One of the things I like to do is to ask myself: Where am I

the strongest? Where am I the weakest? Look at that closer. What

am I going to do about it? If I have a tendency to hesitate when it

comes to executing a trade, what does that tell me? Why do you

and I hesitate to do anything in life we feel we should be doing? We

arent that condent, we arent that sure what we are going to do

next. But if I know that by following some of the elements we talked

about, if I know how much patience, then I have a way of increas-

ing my condence and comfort when it comes to making a trade.

Dan Gramza is President of Gramza Capital Management.

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Born in 1878, W.D. Gann was one of the pioneers of technical

analysis and one of the most successful traders of his time. His

concepts and techniques still apply to trading today. Gann was

foremost a nancial astrologer and spent countless hours studying

cycles, numbers and Gematria to predict not only movements in

stock and commodity markets with great success, but also horse

racing and the Cuban lottery. The Gann system is the one I prefer

to use in my own trading for predicting cycles, markets and trends.

It can give you a roadmap of the marketsif you take the time to

unlock its secrets.

Gann had become somewhat of a legend even before his death in

1955 for his predictive abilities. He forecast the exact top and price

in the cotton market on September 8, 1927, (in his book Tunnel

Thru the Air) and its even said he predicted World War I in 1914 as

well as the resulting panic in stocks. He was often correct about

commodity market trends back in the 1920s and 1930s, and his

track record of winning trades was extraordinary indeed. He had

accumulated more than $50 million until his death, an impressive

sum for that era.

Gann believed to successfully trade the commodities markets,

you must follow a dened set of rules, never to be violated. His

28 Valuable Rules are still valid for traders today, and I read them

every day. Usually when Ive been unsuccessful trading, Ive found

its because Ive broken one of the rules. Ill outline a few of Ganns

28 rules in this article, but I encourage you to seek out and study

all of them further.

HISTORY ALWAYS REPEATS

Gann wrote: Time cycles repeat because human nature does

not change. That is really the backbone of much of his predictive

market analysis. The trend is your friend is truly Gann philosophy

at its most basic. Gann always looked at the big picture rst and

felt if you study the past, the future will become an open book. The

big cycles, the great cycles, are where the most money has been

made, so follow the main trend.

He studied the CRB Index (a commodity index), the Dow Jones

Industrial Average and the bond market, which he felt were

the three main indicators for boom-and-bust cycles in the econo-

my. He pored over data back to 1259 A.D. in the wheat market

and back 400 years in the cotton market. He used wheat to predict

war periodshe found when wheat was booming, there was

usually war.

HEALTH, KNOWLEDGE, MONEY MANAGEMENT,

CAPITAL AND PATIENCE

Ganns 28 rules are based on these ve things. Gann believed that

you are what you eat, and because he studied long and hard, he

wanted to have a very alert and astute mind. He was very health-

conscious and did not smoke or drink. Gann felt one should never

trade when sick or stressed, because your judgment becomes

impaired and you make the wrong choices. When that is the case,

its time to take care of yourself and go on holiday to rejuvenate

your body and mind.

Gann also believed you can take away all a persons money,

but not his knowledge. So, you must gain understanding of the

markets before you trade. If you are starting out, it will be advanta-

geous to paper trade for a time to see if your system works. Youll

then be a step ahead of everyone else. Study the history of stocks,

commodities and interest rates, wars, elections and weather. Gann

studied these all of the time. Understand the tools of the trade, and

understand the main market cycle you are in.

Gann never believed in debt. He felt you should work on being

debt-free before you are 45 years old, to save and prepare for re-

tirement. You should also have at least a years wages in the bank

in case you lose your job. This was recommended 100 years ago,

The Brilliance of Gann in Todays Markets BY DAVID BURTON

The Gann system is the one I prefer to use in my own trading for predicting cycles, markets and trends. It can give you a roadmap of the marketsif you take the time to unlock its secrets.

THE BRILLIANCE OF GANN IN TODAYS MARKETS21i

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and is still good advice today. Gann said you should never have

more than 5 percent of your net worth in the market, and when

trading futures, he recommended you have three times the initial

margin per contract. For example, if the initial margin is $1,200 for

one contract for soybeans, you would have available per contract a

total of $3,600.

It is also important to always keep your trading capital separate

from your living capital and assets, and never borrow against as-

sets to trade. Save up money for your trading capital. As mentioned

previously, trading capital should be no more than 5 percent of

your net worth. If you cant make money out of your trading ac-

count, there is no point in throwing good money after bad.

Patience is a virtue. Gann suggested that you trade three to four

times per year, per commodity. For this, you will obviously need

patience and discipline! If you follow Ganns 28 rules, this will also

help you to be patient. Wait for major setups as more money is

made in long bull or bear campaigns.

A few more Gann-based rules I live by:

Always have a maximum 3 percent stop loss Divide your capital into 10 equal parts Only trade trending marketsalways leave dead markets

alone; trade markets with at least 30 years of data, so you

can track long-term cycles Read Ganns 28 rules at least once every day, and make sure

you dont break any. They are found on page 43 of Ganns

book, How to Make Prots in Commodities.

GANNS TOOLS

Ganns system is highly complex and a lot of his writings were

veiled in secrecy. He used a combination of methods to determine

future trends of the markets.

These methods include:

Resistance levels made by market uctuations Geometrical angles Time cycles and time periods (Ganns cycles were 90, 84,

60, 30, 20, 13, 10, nine, seven, ve, three and one-year) Squaring out price with time from tops and bottoms Odd and even squares and the halfway points between both

odd and even squares Weekly high and low charts, angles that form from tops

and bottoms

Monthly high and low charts, angles that form from

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

For an example of Gann cycle analysis, the wheat market showed

bearish patterns in 2005. I subtract these large cycles from 2005.

These cycles proved low years in 1645, 1915, 1945 and 1975.

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

Gann never revealed his secrets to anyone unless they did the

work, including his own son. His philosophy was basically, work

hard and the secrets will come to you. Gann coded his books so

his followers would work hard to gain the knowledge contained

in them. You can download an eight-page partial decoding of his

book, Tunnel Thru the Air at www.schoolofgann.com. Here youll

also nd more information about Gann for further study. As Gann

once said, Knock on the door and it will be opened unto you, seek

and you shall nd.

David Burton is Managing Director of Commodity Hedging Company and offers workshops and home study courses on Ganns methods through his Web site, www.schoolofgann.com.

THE BRILLIANCE OF GANN IN TODAYS MARKETS21i

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When Trends Arent Your Friend: How to Approach Drawdowns BY JOHN TOLAN

With any investment you are going to experience losing periods, and trend- following strategies are no exception. How you choose to deal with these drawdowns can be the difference between sleepless nights and condence in your investment approach.

Im sure youve heard the popular adage that guides many suc-

cessful traders: The trend is your friend. Its based on the simple

philosophy that if you stick to trading the prevailing trend in any

market, youll have more success than trying to go against it. There

are many popular trading systems based on this methodology, with

unique variations in their approach. But what if the trend isnt your

friend, and you experience a losing period? What if tradable trends

fail to materialize, and/or your trading system is having trouble

coping with a volatile period? With any investment you are going

to experience losing periods, and trend-following strategies are no

exception. How you choose to deal with these drawdowns can be

the difference between sleepless nights and condence in your

investment approach.

Every time traders or investors go through a difcult period, they

tend to ask the same questions: Have the markets changed? Has

trend-following stopped working? Does something need to be

xed? Should I close my account? Should I trade another system?

Before you jump ship, please take a moment to consider your deci-

sion from a long-term, trend-following perspective.

DRAWDOWNS ARE NORMAL EVENTS

Of course drawdowns are unpleasant. But, they do not signal that

something is wrong with markets, trend following, or the future.

History has shown that change is constant, change is random, and

trends will appear again if we go through a period of non-trend-

ing markets. Choppy, sideways markets are a precursor to future

trends, whether they are up or down. Therefore, when you experi-

ence this type of action, you can look at it as a waiting period for

some possibly dynamic trends in the near future.

Its important to remember these four points.

1. Stick to your trend-trading system. Dont let a series of losing

trades, in the short run, cause you to lose condence and deviate

from your long-term trading plan.

2. Even the best systemsall systemsgenerate periods of

losing trades and account equity drawdowns. Thats reality.

Just as market prices move in trends, so will your trading equity.

That is how the markets work and how trend-trading systems

work. Up trends tend to be followed by sideways and down trends.

Protable periods tend to be followed by losing periods, which

tend to be followed by protable periods, etc. Its what to expect.

3. These equity swings will test your trend-trading discipline.

Dont get optimistic when youre making money and add to your

position size. This may result in doubling the magnitude of your

next drawdown.

4. Dont let your emotions, whether up or down, affect your

long-term trading plan. Have realistic expectations and stick to

your plan. If you cant accept losses as part of the process, then

trend-trading will not work for you. You must be prepared to evalu-

ate your trading performance based on many trades over a long

period of time. This discipline is the key to trading success; your

trading edge.

WHEN TRENDS ARENT YOUR FRIEND: HOW TO APPROACH DRAWDOWNS21i

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TREND-FOLLOWING ISNT PERFECT, BUT HAS

HISTORICALLY BEEN VIABLE

Like democracy, trend-following has its critics. Trend-following isnt

perfect, but over the long run, many investors have found it to be a

viable strategy.

You must evaluate your own nancial situation and risk tolerance

to determine what is suitable for you. If trend-following were a

perfect strategy with high returns and no risk, everyone would do

it successfully. But trend-following, like all strategies, has its aws.

Volatility. Losing trades. Drawdowns. The reality is that the masses

tend not to learn from history, human behavior does not change,

and so history repeats itself.

John Tolan is a Commodity Trading Advisor.

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The Commitments of Traders Report: A Clue to Whos Moving Markets BY KRISTINA ZURLA LANDGRAF

The Commodity Futures Trading Commissions (CFTC) Commitments of Traders (COT) Report offers a weekly glance into positions various groups of market participants are taking in the futures markets.

Ever wish you could get some insight into what other traders are

doing? How the biggest players, such as large funds and institu-

tions, may be positioning themselves in the markets? The Com-

modity Futures Trading Commissions (CFTC) Commitments of

Traders (COT) Report offers a weekly glance into positions various

groups of market participants are taking in the futures markets.

Many analysts use the report to help determine what trends could

come next, and its a tool you might nd useful in your trading

as well.

The CFTC puts out its COT reports each Friday at 2:30 p.m. Cen-

tral Timeone for futures and one combining futures and options.

The reports contain a breakdown of open interest for markets in

which 20 or more traders hold positions equal to or above levels

the CFTC has established, as of three days prior (Tuesday) that

same week. The categories of participants are grouped into re-

portable and non-reportable positions. For reportable positions,

data are provided for commercial and non-commercial holdings,

spreading, changes from the prior report, percentage of open

interest by category and number of traders. A long version of the

report also contains information on data by crop year, where ap-

propriate for agricultural markets, and shows the concentration of

positions held by the largest four and eight traders. You can go

to the CFTCs Web site at www.cftc.gov to obtain current and

historical data.

Its important to know what the CFTC is reporting, so below are

brief denitions of some of the terms in the COT. Well explore later

how some analysts use this data to help determine market trends,

and what you might look for.

CFTC COT DEFINITIONS

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

tion contracts entered into and not yet offset by a transaction, by

delivery, by exercise, etc. The aggregate of all long open interest is

equal to the aggregate of all short open interest. Open interest held

or controlled by a trader is referred to as that traders position.

Reportable Positions. Clearing members, futures commission

merchants, and foreign brokers (collectively called reporting

rms) le daily reports with the Commission. Those reports show

the futures and option positions of traders that hold positions

above specic reporting levels set by CFTC regulations. The aggre-

gate of all traders positions reported to the Commission

Trading Futures Guide

Documents

Transcript of Trading Futures Guide