Futures Trading

Trading the commodities and futures markets: A survival game

Everyone who plays with the idea to speculate with commodities or futures, should step back now, take a deep breather and reevaluate this plan. These markets are a game of professionals - and I am inclined to add here - for the likes of them. Numerous studies have shown, that for most private traders (more than 90%) this is a losing game. Being a classic zero sum game overall, there must be someone who wins, and that someone is a minority of professionals.

The slippery churning of brokers, dealers and floor traders

Fees and spreads have to be paid in all financial markets to buy or sell something, but open outcry markets have a tendency to make prices run away in the wrong direction for orders from outsiders that seek to be filled. It remains an unanswered question whether the pure specialist system of listed stocks like the old NYSE, the competing market maker system of NASDAQ, either one combined with a competing electronic order book or the open outcry market is the fairest market. Pit traders like to accuse specialists of having too much power to manipulate their prices. They conceal that specialists have the obligation to make an orderly market with guarantees for reasonable fills. Taking into account that open outcry traders tend to behave coherently, there is no big difference to the specialist's power. Both, but even more the pit traders, resist to compete against a computerized market like an ECN or outright refuse to trade off-floor through a computer system, which would put them on par with other market participants.

Contrarian trading - the advantage of the producer

Price movements especially of futures markets are noisy. There are random fluctuations and self-induced starts or breakouts, which later prove to be non-substantial. This is the fundament for an anti cyclical trading strategy - buy low and sell high, or the other way round. As studies have shown, hedgers, companies or entities which sell what they produce or buy what they need for producing, are the big winners of the commodities and more general the futures markets. They often have a better insider knowledge about what is going on in their market than anyone else. Adding to that, they have the advantage that they are hedging - they actually only need to conduct one side of the trade, either they buy or they sell. This gives them the ability to calculate their trade in the light of their main business, which essentially caps their risk. Also, being better capitalized, they can afford to be longer term oriented.

For the private trader or speculator the contrarian system could prove disastrous. What if the price move turns out to be substantial and results in a trend or at least a new level of price? Combine the counter cyclical market entry with a stop loss? This would be a self contradicting system. A trading strategy which is incoherent is most likely invalid as a system. Having no stop loss is of course even worse. That's how amateurs go broke even in the stock market, which lacks (short or margin operations aside) the infinite risk practically created by leverage in the futures market.

Sometimes producers choose to go with what they see as an emerging trend or what they anticipate to become an enduring new supply and demand situation, so of course they are not bound to the countertrend method, but the long term contrarian trading strategy is only appropriate for them. To emphasize it again, as studies show, they are the big winners.

Following the trend - holy grail or well known secret of trading futures?

The third group of winners in the futures markets are so called commodity trade advisors (CTA), hedge fund managers and some well capitalized and experienced individual speculators. They are primary - as long as they make money - procyclical. They try to buy high and sell higher or vice versa. Is it this easy? No, even the most successful traders of this group suffer severe setbacks, they just won't tell it you. However, they have some advantages over the ordinary speculator. They are bigger in size, they use sophisticated statistical methods to create mechanical trading systems that actually do make money, they know about the importance of good money management and they are generally more experienced.

Creating breakouts of ranges or starts and turns of a trend

The naive way to start trading trends might go like this: Take a chart book, spot some trends and get the impression, that one just had to enter the market here and leave it there to become rich. Well, that's hindsight! To get early on a trend and to ride it as long as possible is easy in hindsight, but hard in reality. First, you have to enter a trend. You are looking for a starting point. That's where the malaise begins. There are strong market players, who produce breakouts of ranges, restarts and turns of trends, because they know many will stumble after them in expectation of a new forming or ongoing trend. If the "trend" turns out to be short lived, they can get out with a profit, because they entered the market at the best levels. Guess what, who pays the bill? Mostly the small private trader, but often enough the professional trend followers, too. That's why the rate of failure among them is much higher than these professionals are ready to admit. Who plays this pattern of buying low, pushing the price through a resistance or turning a trend around in order to hopefully initiating the next round of directional movement? Probably both - producers and trend followers, they just have to have enough capital. The futures markets are exceptionally prone to false breakouts and trends have wilder swings, tempting speculators to leave early or enter late - possibly with a loss. Just have a look at charts, and compare them with the stock market. But be cautious, this is easier said than done - the human mind is a pattern recognizing machine - it will always find the patterns it is looking for.

Using statistics to develop a mechanical trading system

One way to circumvent this problem of an optimistic mind finding occasions not only occasionally is to compile a trading system into an algorithm, which is then followed by a computer without being distorted by sentiments and psychological effects and without making mistakes by lacking discipline. But first one has to identify an edge, which is statistical sound. This means that you can use statistics to crystallize a system, which - so to speak metaphorically - meanders around all pitfalls, all the edges winning players have. Of course there is not much space for winners left, and that's why even professional system traders often lose, too.

The typical private trader has really a disadvantage in this area, he is just not sophisticated enough. He might buy complete systems or programs, which can evaluate trading systems, test them and optimize them, but mostly he is not aware of the mathematics, which are behind all this. Over-optimization or curve fitting is one cardinal sin, second guessing of trading signals another one. The typical trader tends to mix up signals of his system with discretionary decisions or tries to change the system every next time. Emotions have discipline in headlock and chaotic behavior is the result - the opposite of a trading system.

Summary of a zero sum game

Brokers charge a fee and have a riskless income. Floor traders slip away and cut out small but constant gains. Producers milk the markets big with contrarian trading. Deep pockets initiate false movements and let others stumble into their losses. The only chance are trends, but they are rare, and they are carved out by statistically sophisticated system traders or producers with better fundamental foresight. The private trader has to make the sum of the zero sum game become zero. He is there to feed the sharks.

Making things worse: Bad money management

An additional reason why so many novices are losing in this game is the lack of proper money management. To put it simple, they are overtrading. Newcomers intuitively often misinterpret the margin they have to pay as their bet size, and that's why they are overtrading grossly. Usually they are out of the game very soon. But even making bet sizes only slightly too big will make your losses overcompensating your gains on average and your capital will decline over time. This holds true even if you have an edge. Bad money management destroys your advantage - if you have one at all. The reason is mathematics. To make a simple example assume that you have no edge, but put on trades with a very big bet size. A typical gain of 50% of your capital has statistically the same probability as a typical loss of 50%. But to recoup the loss you must win 100%! Even optimistic advantages will get converted into their negative counterpart by what I call the relative-absolute effect.

Source: www.visoracle.com

Stock Investing

How to become rich by investing in the stock market?

Don't be the Investor!

Millions of people are lured into buying stocks, based on promises by the - what it likes to call itself - financial industry. These promises are disguised as only a few outstanding success strategies.

Let us start with what everyone considers to be the more dumb ones:

• Watch TV or read the newspaper and simply go with the flow, do what other do, buy some arbitrary stocks and wait for the big money.

• Have a friend who recommends something or whose gains makes oneself jealous, and be eventually talked into investing or trading.

Here are the ones, which seem to be much smarter:

• Use charts, find patterns and calculate precise entry points to have an edge.

• React to news and price changes quicker than quicksilver and have a speed advantage.

• Be a fundamentalist, analyse and examine every data that comes out of a company, and then buy only cheap at a reasonable price.

• Make global judgements about the economy and hit the right turning point for a general entry into the market to elegantly avoid analysing details of pea size.

• Buy the broader market with index funds, based on the idea that overall the stock market reflects the ongoing advance in the world and thus stock indices are doing well longterm.

• Delegate the work of making investment decisions to a professional, who, because being a professional, should outsmart the market.

Most people adhere not only to a single pure form of these strategies. They rotate between them, they try different flavors of them, they mix things up, they even start an investment with one strategy and close it with another. Or they start trading and end up with an investment. But important here is, that the latter behaviors seem to have all good arguments. The former types of "investors" are in one sense rare - if conducting a statistical inquiry, most participants would think of themselves belonging to the smarter group and would find their reasons and reasoning of why and what they are doing among the latter strategies. That is why it is generally believed that investing in the stock market will make people wealthy.


Now let's consider a different view of the stock market, a table with six players.


In the middle we have Mr. Doe, the private investor, left to him sits Mr. Clever who is a professional fund manager and at the right of him is Mr. Smart, a professional money manager for individual clients. On the other side of the table we have Mr. Broker, Mr. Market-Maker and Mr. Company. They all are doing what the market does - they are exchanging stock shares and bank notes, putting them on the table and taking them away at times. Let us concentrate on the money only, after all the money is the only thing that counts. Neither has the table a hole through which money could vanish, nor does money rain onto it. All money put onto or withdrawn from the table has to go through the player's hands. Let's have a look at Mr. Broker first

Busy Mr. Broker only sells and always wins

He charges a fee for simply forwarding an order from Mr. Doe, Mr. Smart and Mr. Clever to someone else. All that without risk and pain, and after doing so he pockets the fee - he takes it from the table. He can't make a loss, so with a bunch of marketing tricks he animates everyone to give him as fast as possible a new order. Important here is, what he does with regard to the table. He never puts money onto it, he only takes money away.

Mr. Market-Maker is known to be in a good trading position

He is the one who takes the other side of a trade and makes a mostly riskless business with the spread, a difference between buy and sell price. Furthermore he has state of the art equipment, which he watches like a hawk all day in a big room with other's doing the same, hoping that many hawkish eyeballs are seeing more than single prey's ones. But that's not all, he is known to be in a strong trading position, too. He works for a big company with much money, which other traders fear, so he is able to drive prices up and down, enticing euphoric Doe into high prices and shaking out trembling Doe with a loss at low prices. He initiates breakouts, which Doe falsely interprets as signals. Doing so he himself buys low and sells high. Some badmouthing tongues even argue that Mr. Market-Maker makes money with illegal insider information, front running or stock pumping. Not enough with that, he is supposed to create up- and downgrades, something like home made news, just to influence supply and demand of a stock to force its price to a level where he can sell or buy with more profit or a smaller loss. Overall Mr. Market-Maker seldom makes a loss, on average, he always wins. To make it short, he too takes only away money from the table.

For Mr. Company the stock market is a real gold mine

He has a special seat, with a big sign above it, on which is written - on his side so that especially Mr. Doe can't see it - "capital source". The other side of this sign could be labelled "capital drain", but that would lower the mood, so it only says "welcome". Mr. Company comes to the table right away from the printing press, with a big chunk of newly created stock certificates - paper, which he dumps on the table while cashing in tons of money. Will he ever give this money back? Hehe, stupid question, no he won't. The alternative for him is to borrow money by emitting bonds, which he obviously thinks of being more expensive in this case than selling paper. After all in the bond market he would have to give back what he borrowed after paying interest for it.

In very few cases his company survives and prospers. Then - in the far distant future - it is expected to pay back something to the table. Mr. Company can ignore such an expectation for a long time or even for the whole lifetime of the company, there is no law requiring him to fulfil it. But he can do so by paying a marginal dividend or by buying directly back some shares from the table, preferably when stock prices are low. That looks good and may cost him no money at all, because there are some nice ways to offset such payments.


• First, while making these payments, he can do a secondary offering. Mr. Company simply comes back to the table and dumps again a chunk of paper on it. Sounds primitive? No problem, he can mask the operation a bit.

• He does it just a bit before or after the phase of payments, preferably when stock prices are high. Buying back low and dumping high is a profitable business on its own.

• Or he creates sort of options by printing the additional word "warrant" or "convertible" on the paper. That means that he starts two dumping actions, one now for the option paper and one later in the future for exchanging the option paper for the original paper, cashing in twice.

• Even better he splits off a part of his company, declares it being a new one and sells paper with a new company name printed on it.

• If he is lazy, he simply distributes paper with the old name to the employees of his company. He can pay smaller salaries this way. Employees get shares proportional to their importance, meaning that he gets the biggest share, because he considers himself of being most important. Instead of one big, many smaller chunks are now dumped on the table.


There is another rare and very special case how money comes back from Mr. Company, a cash paid take over. Another Mr. C arrives at the table and buys with real cash all paper of Mr. Company from Doe, Smart and Clever back. But usually this other Mr. C got the whole money from the table firsthand, so this way nothing really comes back.

Actually Mr. Company is supported by two other persons behind the scenes. Mr. Investment-Banker helps carrying Mr. Company's paper chunk to the table. With much trumpeting he praises its quality as an investment. If Doe, Clever and Smart are nonetheless skeptical, Mr. Market-Maker, with his many tricks, makes the new stock's price going up. Then Mr. Doe loses all doubts and shoves the tons of money over the table to Mr. Company. Mr. Investment-Banker's risk is that he projects too big a chunk of paper for the table, so that he has to push the missing tons of money to Mr. Company, but that happens rarely. Mostly Mr. Investment-Banker just gets his fixed percentage of the tons of money from Mr. Company. Seen as an entity both will of course always drain money from the table during the paper dumping action.

Mr. Company's second supporter, Mr. Venture-Capitalist, got beforehand his own chunk privately from Mr. Company in exchange for money, hoping that Mr. Company raises the seed and is invited by Mr. Investment-Banker to the table eventually. He may even get a chunk from Mr. Company later when the stock is already on stage, typically for a better than the price at the table. In both cases he hopes that he can sell his chunk for a profit, which may or may not come true, but at the table he will never do anything else than dumping his paper and raking in money.

So we have three gentleman at the table taking away money. Some do it gently but constantly, some more raid-like.

Finally Mr. TaxMan appears every now and then, grabbing some money from the table and out of the trouser pockets of the participants and grins. Of course he never puts money onto the table either.

What about Doe, Smart and Clever? Well, they are fighting for who has to put the least amount of money on the table to feed the other side. We know that Clever and Smart are acting on behalf of Doe. They get a riskless payment from Doe for this fight, so it is not really that important for them whether they lose more or less.

It looks as if poor Mr. Doe is the real loser in this game. Interestingly Mr. Doe has a different perception of this.

But I already made a nice gain in the stock market !?

This seems to be a paradox. Yet it is none. The table view of the stock market is a totalized one, a view which cares only for averages. Of course there can be many individual Does having made their profit in the market, but on average Doe is the big loser. There can be a market maker, who suffered a big loss, which he never recovered, because he went broke. Yes, there even can be a company caring for its shareholders buying back stock shares and paying dividends with every free cash it earns doing its business, not offsetting these payments with tricks Mr. Doe is not aware of.

A second point of confusion is what happens away from the table. Mr. Market-Maker or Mr. Broker may have to pay a hefty monthly bill for their equipment, salaries and rent, so that they only break even. Mr. Venture-Capitalist may enthusiastically invest in any nonsense idea he hears of, so that he overall makes a loss. Mr. Company may have the wrong concept, not enough talent or too much competition, causing him to burn all money and go broke. He may be a genius, resulting in ever growing earnings of his company. All that is not important for the table model of the stock market. Even a rising price of a paper on the table doesn't matter. It looks like Doe, Smart and Clever are winning in this case, but alas, high prices are only tempting Mr. Company to dump the next chunk of paper. The only question that counts, is

Does the money flow through a player's hand from or to the table ?

The futures market is called by many a zero-sum game, because for every contract traded, there is a buyer and a seller and what one wins must be paid by the other. There is the proposition that the stock market is a positive-sum game, because over a long term, let's say some decades, stock market indices went up. Well, the table model suggests that the opposite is true. For Doe, Smart and Clever it is a negative-sum game. How can that be? Over time problematic index stocks get replaced by fresh ones with brighter future perspectives, so indices are distorted. But the main reason is simply, that all the owners of stock own paper but not money. If they all wanted to exchange their paper into money to get what the ever rising indices promise, these indices would drop to zero immediately. The stock market is basically a pyramid scheme, which implodes eventually, sometimes self induced, sometimes triggered by external events. More often it implodes only partly for some stocks or temporarily and so that not all stocks recover. That may be one reason why all this is so hard to believe.

Back to the beginning to the more smarter strategies how to beat the market. Will they not allow you to make money in the stock market? Doe, Smart and Clever are essentially fighting for a positive piece of a negative cake. So you nearly have to be a wizard to succeed. At least you have to be very good in your niche. This innocent little sentence contains what the Visoracle considers to be

The first and most important secret to make money in the stock market

You are destined to lose. If you aim to be a wizard and turn your fate around, you have to have a niche, a specific system in which every part fits to every other. Every particle which doesn't fit, drastically lowers your chance of success. Amazingly you are yourself one particle of the system, your strategy must fit to your personal psychology, you must feel comfortable to follow it. It is possible to combine and refine above mentioned smart strategies, but never stop searching for the grain of sand that blocks the gear. Think about the tricks of Mr. Market-Maker, Mr. Broker and Mr. Company and design your private investment or trading system around their traps. You have to trade or invest not only wisely, you have to do it differently.

The red hot trading system and the proven safe investment strategy

for which you may have been searching so long, are exactly the wrong way. You have to avoid everything prefabricated or you are perfect food for the sharks out there. Using a published system out of the box will always put you in a predictable crowd. You may even be riding a Trojan horse, originally designed by one of your enemies. Moreover it will not really fit to you, and it probably has other grains of sand in the gear. But beware, just mixing popular trading or investment system elements crudely into another system, disregarding the traps, will only add some big stones to the grains of sand. A better idea is to let existing strategies inspire you. Have a look at their elements from the perspective of the sharks, combine fitting ones and think through the whole. Before the Visoracle wishes you good luck, which you will need for surviving in the stock market, let me emphasize here again: If playing a negative-sum game against sharks and random, you at least must not be predictable, as the mathematics of game theory shows. You have to create your own very personal and specific system.


Source: www.visoracle.com