Commodity Futures - Overview

This week, this post supplies daily pivot points for E-Mini S&P futures.

In the near future, we will offer an online, interactive pivot calculator that you can use for any market to compute pivot points.

If you are interested in additional support and resistance levels for a particular market, using pivot analysis and other techniques, contact us and we will supply you with the information you require.

** Support and resistance numbers are rounded to the nearest point.

Pivot Support and Resistance Levels for the week of October 20, 2008

December E-Mini S&P 500 Futures

Resistance 3: 1268.75
Resistance 2: 1157.00
Resistance 1: 1045.25
Pivot: 955.25
Support 1: 843.50
Support 2: 753.50
Support 3: 641.75

From time to time, markets experience extreme price movement, such as price movement in Gold and Crude Oil Futures. In these extreme cases, we significantly surpass pivot levels that are calculated using standard Pivot Point formula.

In such cases, traders sometimes double “logical” components of price values indicated for a given support or resistance level.

For example, base on last week’s Crude Oil Futures price, the second resistance level was computed as 114.84. We dramatically traded through this level; however, pivot analysis can still be useful.

For example, if resistance level II was at 114.84, we can produce a correlated level by doubling part of the dollar portion of the price - this would give us a value of 128.84.

However, a certain level of judgment is required when using adjusted pivot levels - we would not want to double the entire price and derive a value of 229.68 (114.84 * 2), as that level would be unrealistic for the market under review (in this case, Crude Oil Futures).

We would double the “tens” portion of the trading price, as it more realistically reflects price action for the market under review.

Who Trades Futures Markets?

Futures traders fall into two primary categories: hedgers and speculators . Hedgers seek to transfer price risk to other market participants in order to partially lock in or protect the value of a physically commodity or to protect against the cost of a future purchase.

Speculators seek to profit from predicting market direction. Speculators trade in varying times, ranging from short term exposure (scalping) to day trading, swing trading, and long term position trading.

Other types of traders are Commodity Trading Advisers (CTAs), Commodity Pool Operators (CPOs).

Together, these varied market participants help determine the fair price of a commodity market through a mechanism known as "price discovery ".

What Are Futures Contracts?

A futures contract is a standardized contract that is traded on a futures exchange that is regulated by the Commodity Futures Trading Commission (CFTC). There are many different types of futures products – agricultural, financial, precious metals, to name a few. Note that each type of futures contract has a defined set of specifications to which futures traders must adhere.

A futures contract requires the market participant to buy or sell an underlying instrument at a certain date in the future, at a specified price. It is important to note that a futures contract gives the holder the right to buy or sell the underlying instrument, but not the obligation to do so. Most futures contracts do not result in actual delivery or purchase of the underlying physical commodity or financial instrument and are offset prior to delivery.

In order to preserve the integrity of each transaction, an entity known as a “Clearing House” functions as the counter party to each transaction. The Clearing House provides other functions, such as margin requirements and settlement mechanisms, however is enough to know that the primary function is to ensure the integrity of each contract. This guarantee made possible by requiring Futures Commission Merchants (FCMs) to have adequate capital reserves deposited at the Clearing House.

What makes trading Futures different than trading equities?

Futures markets provide leverage not fundamentally inherent in other investment vehicles, such as stock or mutual fund trading. It is critical to understand the implications of futures market leverage. Simple examples illustrate how leverage allows the trader to profit in futures trading with a substantially smaller initial investment than would be required for an equity trade. The next section describes contract specifications and leverage in more detail.

There are other details that differentiate stock trading from futures trading, however we will not examine them here. We are concerned with the primary difference, which is leverage.

Contract Specifications and Leverage

Every futures contract has specific components that define the contract and influence the amount of leverage for the contract. You should understand as much about a contract’s specifications as possible.

Let’s look at Corn futures as an example. Contract spec information includes:

The contract size = 5,000 bushels per one contract.

The contract trades in ¼ cent minimum increments.

¼ cent = $12.50 / $.01 = $50

Initial Margin is set by the exchanges. Initial margin and can be modified by the brokerage firm if it so desire varies. For Corn, initial margin is typically between $800 and $1200 per contract. Maintenance Margin is typically between $500 and $800. Don’t worry too much about terminology for now. You can consult our Glossary of Terms for more information about a given term.

Furthering our example of leverage, assume you receive a signal that indicates corn will move from $7.60 ½ to $7.72 ½. For this example, let’s assume Initial Margin = $1000/contract. For one contract, you will invest $1000 on this trade. If you are correct in your market prediction, you will make $.12, which is equal to $600. The math is computed as follows:

The purchase price is $7.60 ½ - at this price, through leverage in the futures contract, you are essentially “controlling” $7.60 1/2 * 5000 = $38,025 worth of corn. That’s a lot of corn to control with only a $1000 initial investment!

You offset your futures contract by selling it at $7.72 ½ - $7.72 ½ * 5000 = $38,625. Your profit is $38,625 - $38,025 = $600.

In this example, you invested $1000 and made $600. On one trade, your return = $600 profit/$1000 margin = 60%. Not bad. Such is the effect of leveraged trading.

Now let’s look at a typical stock trade. Suppose you are trading Microsoft stock and want to make the same $600 profit you made on your Corn futures trade.

Assume Microsoft is trading at $30 / share and you predict a $1 upward move in price. Without leverage (i.e. you are not trading stock on margin), you would need to purchase 600 shares, at $30/share. If the stock were to rise $1.00 to $31/share, you would make $600.

However, let’s look at the required initial investment - 600 shares at $30/share = $18,000. If the stock moves to $31, you sell it at $18,600. You make $600, net profit. However your return on investment plummets. It is computed as: $600 profit / $18,000 initial investment = .03%

Compare our 60% return on our futures trade versus 3% return on our stock trade. Of course leverage works both ways – you can make tremendous profits, however the risk of loss is also great. However in the section of this site that recommends how to trade futures, we will describe ways to limit our losses if we are incorrect in our trading decisions.

In order to begin trading futures, you must select a commodity futures broker. How do you find a futures broker? What is the most important component of finding and selecting a futures broker? We believe innovation is the key - most futures brokers offer competitive rates. What makes them different? Unique services offered by a futures broker make finding a futures broker easy. This site is devoted to trading, but is biased towards technology and automated or black box systems trading. Therefore, when selecting or finding a futures or commodities broker, please think about more than commission rate. Think about technology, black box programming services and the ability to have direct access to individuals within the brokerage firm (or FCM) that will assist you and help you achieve your trading goals.

There are many to choose from and most offer competitive commission rates.(please contact us for a recommendation.).Ideally, your broker should be technically savvy, and preferably, should have decent computer programming skills. Again, do not worry about commission rates - most brokers are very competitive with their rates. Focus on finding a broker with technical skills that can help you develop your systems, teach you technical analysis and provide information about risk management.

Once you have selected a broker, make sure that you have a powerful computer, fast and reliable Internet connection, charting software, access to real-time quotes and a good trading platform for trade execution.

These operating costs are minuscule. More discussion will be provided later, regarding which charting tools are suitable for a given investor.

This site is advocates using technical analysis for trading futures. There are many sources of information for learning about technical analysis, including books, magazines, blogs, newsletters or online forums related to futures trading and technical analysis .

You do not need dozens of books about futures trading or technical analysis, however, in addition to finding information online, I recommend that you purchase several books and outline or highlight important topics you cover as you study technical analysis.

Read as much as you can about technical analysis. Each time you read about technical analysis, you may gain additional insight, or a paragraph may spawn a trading idea you would like to implement and test.

Check out the Recommended Readings Category of this site.