onewho is financially responsible.
OPENING AN ACCOUNT
Let’s quickly review the different types of commodity futures trading accounts you can open and the basic forms you’ll be asked tosign or acknowledge understanding of. Some of this will varyslightly from one FCM to another, but there should not be too muchvariation.The types of accounts include:Individual account. An individual account represents the account of one customer as an individual.Sole proprietorship. A sole proprietorship is the same as an individual account except that the account is in the name of asole proprietor.Joint account. A joint account represents an account established in the names of two or more people. Joint accounts require information on all parties to the account.General partnership account. Basically, a general partnership isa business arrangement between two or more individuals orbusiness entities, each of whom is a general partner conducting a business in the name of a partnership. Each generalpartner can make decisions on behalf of the whole partnership. The business of the partnership is usually conductedpursuant to an organization’s agreement in accordance withstate law. A general partnership can be established to conducta full-time business, such as commodity merchandising, orfor a specific investment or trading activity, such as futurestrading. An important aspect of a general partnership is thateach general partner is liable for commitments and debts incurred in the partnership.
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Limited partnership. A limited partnership is primarily established for investment, rather than for general business activities. It is usually established and operated pursuant to an organization agreement in accordance with federal and statelaw. An important aspect of a limited partnership is that thelimited partners are not involved in the management of thepartnership, and each limited partner’s liability is generallylimited to the amount of the individual’s investment in thepartnership.Corporate account. A corporate account is an account established by a corporation. The information for individuals isnot required, but corporate information must be submitted.Additionally, a corporate resolution allowing the corporationto trade futures and options on futures must be completed,and it must be signed by at least two officers of the corporation. The account papers must indicate who is allowed totrade on behalf of the corporation. In addition to this document, the corporation must submit either a personal guarantee or a copy of the firm’s most recent audited financial report.Trust account. A trust property is controlled by one person forthe benefit of another. For example, a father may create atrust (and be the trustee) for property held for the benefit ofhis minor children. Or a pension fund could hold funds forthe future benefit of members of that fund. In order for atrust to trade futures, the trust agreement must specificallyauthorize it. A copy of the trust agreement is usually requested with the account papers.The package of forms you’ll receive to sign is generally calledthe account papers. Each FCM prepares its own account papers, butall papers must meet the requirements of the regulatory agencies(the CFTC and the NFA). (See Fig. 4.2.) For this reason, there is astrong similarity among all the forms you’ll see.One of the first things your broker is charged to do, by the National Futures Association in its Compliance Rule 2– 30, is obtain information about you. The broker must be able to prove to the NFAthat you are known and you are who you say you are. Specifically,your broker needs (1) your true name and address, (2) your princi-
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4.2
Futures Industry StructureU.S CongressCommodity Futures Trading Commission (CFTC)National Futures Association (NFA)ExchangesFutures commission merchants (FCM)Introducing brokers (IBs)IB branch offices
pal occupation, (3) your age, and (4) your previous investing experience.The purpose of this information is to assess your suitability totrade futures. You will be asked to answer a series of questions and/or fill out some sort of financial statement. In addition, you’ll needto supply information about your previous investing experience.The next part of the account papers includes a variety of riskdisclosures. The purpose is to make you fully aware of the seriousrisk involved in investing in these types of investments.The Non-Cash Margin Disclosure Statement is a statement provided so that you understand and acknowledge that in theunlikely event that the FCM becomes bankrupt, funds notheld in segregation (i.e., held as T-bills) will be returned toyou based upon your pro-rate share of all property availablefor distribution.The Commodity Account Letter and Customer Agreement shouldbe read carefully. It highlights the following areas: order entry, margining, commissions and fees, commodity options,delivery and short sales, security interest, liquidation, foreignexchange rates, customer representations and warranties,market recommendations and information, communications,credit, recordings, terms of the agreement, and miscellaneousprovisions. The customer must sign this acknowledgment indicating that it has been read and understood. All parties tothe account must sign and date this agreement.The Lending Agreement comes into play when a customer
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makes or takes delivery, which is unusual. If the balance inthe customer’s account is not adequate to pay for the delivery, and the delivery creates a deficit in the customer’s account, a signed Lending Agreement allows for the FCM touse the commodities or evidence of ownership of the commodities as collateral for a loan. The proceeds of that loan areused to pay for the delivery until redelivery of the commodity and/or payment in full by the customer can be completed.The Permission to Cross Agreement allows the FCM to unintentionally take the opposing side of any trade that may havebeen placed on behalf of a customer. The CFTC requires theFCM to get your permission to take the opposite side oftrades. Since the FCM handles so many trades each day, itasks for your blanket approval because it doesn’t have anypractical way of keeping track of all the possible conflicts ofinterest.The Options Disclosure Statement informs you of the risks associated with trading options, as well as describes the different types of options traded.The Transfer Form should be completed if you are transferringyour account from one FCM to another.The Pre-dispute Arbitration Agreement allows for the filing ofan arbitration conducted by a self-regulatory or other privateorganization rather than pursuing the matter through civilcourt litigation. The arbitration agreement does allow you torequest a Section 14 reparations proceeding before the CFTC.You have 45 days from the date of such notice to decide. NFArules prohibit the signing of this agreement to be a conditionof opening an account.The Risk Disclosure Statement discloses to you the variousrisks associated with futures trading. CFTC Regulation 1.55requires that each customer receive and sign a copy of thisstatement before an account can be approved to trade. If anaccount executive ever plays down the importance of thisdocument, you should be concerned. It’s important that youread and understand what you are getting into.Once you complete the account papers, you send them to yourbroker. They are reviewed by the supervisor. This is usually done at
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the introducing broker level. From here, the papers are sent to thenew account department at the FCM for its approval.When your account is approved, it must be funded before trading can begin. This is usually carried out by bank wire or by check.Therefore, if you’re anxious to trade, send funds with your accountpapers.THE KINDS OF ORDERS
Understanding the types of orders and when to place them is one ofthe investor’s greatest safeguards. Study the following carefully:
Market OrdersMarket orders are orders to buy or sell at the current price as quickly as possible. In the trading pits, they are the first orders to be executed because they can be filled at any price. You use them whenyou want to get into or out of the market quickly. You’re trying tocatch a move, and you don’t want anything to slow you down.There are no contingencies placed on the orders.When you get the fill back, it may or may not be close to themarket price when you placed the order. If the market is on fire,there may be a substantial difference. With orderly markets, it maybe right on the money.When you place a market order, you pass the responsibility tothe floor brokers to fill the order as best they can. These brokers aregoverned by CFTC and exchange rules to give you the best possibleservice. And they do. But you don’t have any control over the market. You never do. When markets are choppy with a lot of volatilityand low volume, you may not want to use a market order becauseyou don’t know when or at what price it will be filled.
Stop OrdersIn special situations, you may want to use stop orders. You placebuy stops above the market if you are bullish on prices or sell stopsbelow the market if you are bearish.Stop orders become market orders when the price trades, or isbid, at or better than the stop price. What you’re trying to do is catch
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a move just as prices break out of a trading range or an area of congestion. Once your stop orders become market orders, you take onall the risk of a regular market order. Namely, you may or may notget a fill with which you are satisfied. Prices could spike up or downto hit your stop and then move against you. By the time your ordergets filled, it’s way above or below the price you were hoping for.That’s the risk of market orders.Stop orders are often used to close out or protect profitable positions. They are called trailing stops. As your long futures or call options-on-futures positions gain value, you place sell stops just belowthem. You continuously move the stop up as your trade becomesmore profitable. If the market moves against you, your sell stops arehit. They become market orders and you offset your positions. Thisis referred to as being stopped out of the market.If you are short futures or holding puts, you can do just the opposite with buy stops. Just place your stop orders above your positions. You wait for the market to “pick off your stops” and close yourpositions, at, it is hoped, a profit.Placing a stop takes some skill and experience. If you place ittoo close to your position, a slight move in the wrong direction removes you prematurely from the market. If you put it too far fromyour position, you can give up too much of your profit before yourstop is hit.To select the right position for your stop, you need to get a handle on volume and volatility. What have the daily trading rangesbeen recently? Is the volume high enough to smooth out the markets?
MIT OrdersThe opposite of stop orders are the market-if-touched (MIT) orders.These are sometimes referred to as board orders and possess two ofthe characteristics of stop orders: (1) They are activated when theirprice is hit. (2) Once hit, they become market orders.The difference is that buy MIT orders are placed below the current market price. (Remember that buy stops are placed above thecurrent price.) Sell MIT orders go above the current price. (Sell stopsgo below the current price.) MIT orders can be used to establish newpositions or close out existing ones.
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MIT orders are not officially recognized on the Chicago Boardof Trade, but a broker can accept them at the risk of the customer.They can be used on the Chicago Mercantile Exchange and on someof the other exchanges. You need to check the individual exchangerules before you make your decision to use them.
Limit OrdersIf you don’t like being left to the mercy of the market when yourstop or MIT order becomes a market order, you can use a limit order (sometimes called a price order). Limit orders are used to buy orsell at specific price levels. Buy limit orders are placed below the going market price. They can only be filled at or below the limit price.Sell limit orders are placed above the current market price and canonly be filled on, at, or above the limit price.Keep in mind that orders other than a straight market orderhave a lower priority. This means that market orders get filled first.In fast-moving markets, you may not get filled at all. Or the marketmay not move to a point where your stop, MIT, or limit contingencyallows your order to be filled. This may keep you out of the market,which may or may not be a good thing.
Stop Limit OrdersA variation on limit orders is stop limit orders. Buy-stop limit ordersare activated when the futures contract trades or is bid at or abovethe stop level. These orders cannot be filled unless the price levelsubsequently stays at, or moves below, the limit level. Sell-stop limit orders are activated when the commodity is offered at, or tradesat or below, the stop level. These orders are not filled unless the pricesubsequently remains at or moves above the limit level.Now, the stop price and the limit price need not be at the sameprice level. For example, an order might state: “Buy 90:16 stop 90:20limit.” This order would be activated when the price hit 90:16, butwould only be fired if the price remained below 90:20.Stop orders are sometimes used for protection in fast-movingmarkets. They let you place orders within price ranges.
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Time Limit OrdersBesides putting conditions on the price of your orders, you can alsoput time restrictions on when your orders can be executed. Thesecontingencies tell the floor brokers when your orders are to be activated.Kill or fill (KOF) is an example. These orders must be filled immediately or they are canceled. Traders use them when they spot atrading opportunity. But since kill-or-fill orders are not market orders, they do not have top priority. On the other hand, floor traderstry to accommodate these orders.Another common type of time limit order deals with placingyour orders in the opening or closing trading range. Market-on-openorders must be filled within the opening trading range, just as market-on-close orders must be filled within the closing trading range.You may want to place standing orders. These are good-tillcanceled orders. Theoretically, these orders will stay in the marketuntil filled. You risk the danger of losing track of these orders—onlyto have one filled just when the market turns against you. GTC orders are not recommended under normal conditions.Another type of time limit order lets one order replace another. These kinds of orders are called one-cancels-other (OCO) orders,where a new order replaces one already in the market.
PRIORITY OF ORDERS
Floor brokers in the trading pits fill the order they have in theirbooks in the following order of priority: (1) market orders, (2) stoporders, (3) limit orders, and (4) limit-price, stop, time. Also, keep inmind that all orders are assumed to be day orders unless otherwisespecified. Therefore, if your order is not filled during a trading session, you would have to reenter it when the next trading session begins. Some markets, bonds for example, have two trading sessionseach day. Orders entered in the day session may not automaticallybe carried over to that evening’s session, depending on your FCM’strading rules. You may have to reenter your orders in the eveningsession or, if you choose, reenter your orders in the next day’s trading session.Good-till-canceled, or open, orders do not always do what the
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name implies. Many exchanges will not accept them. If an order isnot filled during a session, it becomes unabled. An unabled order issimply one that cannot be filled during a specific trading session orwithin the given price-time limit.Your orders may also be characterized as out of range. Thismeans that the orders are out of the normal trading range for thatcommodity. The trading range reflects the daily trading limit. Forexample, the daily trading limit for corn is 10 cents per bushel. Ifyour order is more than 10 cents above or below the opening price,it would be out of range. Most exchanges will not accept outof-range orders. With options on futures, there are no daily pricelimits.Take note also that grain orders use a different nomenclaturethan other futures contracts. Grain orders must be stated in thousands of bushels, rather than numbers of contracts. For example, ifyou’d like to buy 10 corn contracts, you’d tell your broker to “golong 50 corn.” Since corn trades in 5,000-bushel contracts on the major exchanges, you would be long 10 corn contracts. If you decide tooffset this position and place an order to go short 10 corn, you onlyoffset 2 of your 10 contracts. You still would be long 8 contracts. Thiscould be a very expensive error.The Mid America Exchange in Chicago trades mini contracts inseveral commodities. The mini corn contract is for 1,000 bushels ofcorn, rather than 5,000. This is another important alternative thenovice trader should consider.THE CLEARINGHOUSE
After you get into trading, it’s good to know just how the processworks after your broker places the order and it is taken up by another trader. That’s where the clearinghouse comes in.A market won’t function without integrity. Buyers and sellerswill abandon or at least be loath to use markets where losers don’tpay up and winners can’t collect. Indeed, such problems with forward contracts led to the evolution of the modern futures contractin the first place.How can exchanges guarantee that a buyer will take deliveryof a commodity or product or that a seller will make delivery aspromised? Moreover, with contracts changing hands thousands of
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times before delivery, how can a trader keep track of who is on theother side of the transaction?Fortunately, the trader doesn’t have to worry about that,thanks to the role of the exchange clearinghouse. Essentially, a clearinghouse takes the other side of each trade on the exchange.Clearinghouses are made up of brokerage firms that are alsomembers of the exchange—though not all exchange member firmsare clearing members. Clearing members must buy stock in theclearinghouse relative to the volume of business that they clear.They are also required to pony up a substantial sum that goes intoa clearinghouse fund that guarantees all trades will be fulfilled incase of default.Exchange member firms that aren’t clearing members mustclear. That is, they must have all trades verified and guaranteedthrough a clearing member.How does the clearinghouse guarantee trades? By the end ofthe trading day, all trades conducted on the exchange are recordedby the clearinghouse. At that point, the clearinghouse takes the opposite end of each trade.Suppose trader A sold a December Japanese yen contract totrader B. At the end of the day, the clearinghouse would stand between the two traders. Essentially, the clearing firm that representstrader A would be short a yen contract against the clearinghouse,while the firm representing trader B would be long a yen contractagainst the clearinghouse. If trader B sold the contract to trader C,then the firm representing trader C would be long against the clearinghouse, and trader B’s obligation would be canceled. Meanwhile,trader A doesn’t need to worry about keeping track of trader C. Andtrader C can sell the yen contract, transferring the obligation to yetanother participant, without seeking trader A’s approval.This differs substantially from the forward market in which atrader must always be fully aware of the changing identity of thetrading partners, as well as their credit worthiness. A futures tradermust also worry about creditworthiness, but concerns need onlycenter on two entities: the brokerage firm and the clearinghouse.
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Overview of Someof the Active Markets
Key Concepts◆ Overview of Grains and Oilseeds (Soybeans, Corn, Wheat,Oats)◆ Overview of Meats (Live Hogs and Pork Bellies, Live andFeeder Cattle)◆ Overview of Food and Fiber (Sugar, Coffee, Cocoa, OrangeJuice, Cotton)◆ Overview of Metals (Silver, Gold, Copper)◆ Overview of Energy (Petroleum and Petroleum Products)◆ Overview of Stock Indexes◆ Overview of Debt Management (Interest Rates)◆ Overview of Foreign Currency
The following is neither an exhaustive list nor an exhaustive summary of the markets available to futures investors. These are merely markets that now have and will have enough trading volume tomake them acceptable for traders new to the futures markets.Nonliquid markets—those that are lightly traded—cause serious problems for experienced and inexperienced traders alike.These should be avoided because their thinness causes minor trading activity to result in a disproportionate amount of price movement or volatility. Additionally, the low volume can, at times, make
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it difficult to open or close positions. You can be unwittingly trappedin these markets or have them unexpectedly move violently againstyour position.The professional trader learns the markets inside out to avoidbeing blindsided by an unexpected market event. Use the followinginformation as a starting point for basic information you may needto know to trade successfully.GRAINS AND OILSEEDSOVERVIEW OF THE SOYBEAN MARKET
Soybeans have been commercially cultivated for at least the last5,000 years, primarily in the Orient and specifically in China. Cultivation of the “wonder bean” is relatively new to the United States(circa 1930), even though the United States is now the world’slargest producer, with about 2.8 billion bushels in 1998. Beans aregrown in this country from the Southern delta to the Canadian border. Iowa and Illinois are the largest producing states.From a fundamental analyst’s point of view, you must determine what will influence supply and demand. Think of it as a balance scale. When supplies are heavier than demand, the price declines. When demand outweighs supplies, prices increase.
Supply SideOne of the keys to the soybean price equation is production. Howmany acres will be planted? What will the yield be?The key to production is weather, but it is a very difficult factor to predict, especially over the growing seasons throughout theentire world. Is there enough moisture to germinate the crop? Willthere be rains through the growing season? Will harvesttime be dryand free of snow?In the Northern Hemisphere, August is a particularly sensitivemonth in which the crop can be made or lost. Pod filling occurs primarily during the first 2 weeks of August. You should be particularly attuned to rainfall markets during this month. The slightestshower, particularly in Chicago, can send prices plummeting. Anyprolonged dryness and prices will take off like the space shuttle.
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Several South American countries, particularly Brazil and Argentina, have complicated the production side of the supply-demand equation over the last 25 years. Brazil’s production grew from364 million bushels in 1974 to 1.139 billion bushels in 1998. Argentina produced only 18 million bushels in 1974, compared with 680million bushels in 1998.The crop year for these countries is essentially the opposite ofthat of the United States. They plant in November and harvest inMarch and April.Soybeans also have a lot of competitors. When the bean iscrushed, it produces oil and meal. Oil competitors include sunflower, palm, and coconut oil. The main meal (or protein) competitor for replacement feed is wheat.
Demand SideThe meal is used as feed for livestock. Therefore, you also need tokeep an eye on hog and cattle prices and numbers. Also, such factors as the acreage, yield, and weather for the other oil producingcrops mentioned earlier must be tracked closely.Demand or usage depends on the beans being in the right placeat the right time at the right price. Therefore, you need to be awareof any export problems (e.g., embargoes, dock workers strikes, etc.)or transportation problems (e.g., frozen rivers in inland waterwaysystems, barge rate, etc.).Since about 50 percent of the United States crop is exported, thestrength of the dollar is critical. The lower the dollar, the greaterquantity foreign countries can purchase. One of the largest importers is Japan. Being aware of another country’s needs for foodand feed and its economic condition can make the difference between picking a winning trade or not.
Technical FactorsAs you can see, following the fundamental side of the market is astaggering task. That’s why so many professionals rely on technicalanalysis.One of the most reliable tools is a seasonal analysis. At harvest,you can expect a lot of beans on the market. Therefore, prices are
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likely to be lower. Prior to harvest, processors use up last year’s production and prices tend to increase.This analysis has been finely tuned. Studies indicate that 70percent of all seasonal tops occur between April and July. By the endof July 80 percent of all seasonal highs are made. Price bottoms—upto 80 percent—occur between August and November.The theory of cycle analysis states that price action will repeatitself in a predictable fashion. For soybeans, two dominant longterm cycles, a 24- and a 39-month cycle, have been identified by theFoundation for the Study of Cycles. Weekly and even daily cycleshave also been isolated.Chart analysis of soybean price activity has been known to bequite reliable. It is often a trending market that can be interpretedfairly accurately. But certain chart formations, like triangles, arevery unreliable. Other chart formations, like head-and-shoulderformations, are very reliable but are seldom formed.OVERVIEW OF THE CORN MARKET
Corn is a member of the feed grains family, which includes corn,sorghum, oats, and barley. Corn is the single largest member of thegroup, accounting for more than 80 percent of the total U.S. production of feed grains.The crop year for corn begins October 1 and ends September30 of the following year. Since corn is a commodity that can bestored for a reasonably long period of time and can be moved longdistances, keeping track of the amount available worldwide is important. For this reason, the U.S. Department of Agriculture releases regular projections of production and disappearances (usage).Corn is grown on every continent except Antarctica. The United States is the largest producer of corn, providing more than 40 percent of world production. China is the second largest producer, withjust over 20 percent. Brazil, the European Union, and Mexico are theother producers of note, although they lag far behind the leaders.Corn is grown in more countries than any other crop, but most consume all their production and do not export.The United States exports a significant amount of its production, ranging from 18 to 30 percent, depending on the size of the cropand the economic conditions around the world. The Pacific Rim region (in Asia) has emerged as the world’s fastest-growing market
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for U.S. corn. There, most of the corn is fed to livestock to producefood for humans. The majority of the world’s population is locatedin the Pacific Rim region.
Fundamental FactorsPipeline supply is the key issue. How much corn is in farm and howmuch is in commercial storage (that is, left over from the previouscrop years)? How much is expected from the current crop that’s stillin the ground? These numbers are then compared with what is expected to be used. The supply-demand equation looks like this:Beginning stocks  production  imports  total suppliesFeed, seed, residual  food  export  total usage or demandTotal supplies  total usage  ending stocks or carryover
In the United States, the import figure is not significant becauseof high production. However, the export figure can make or breaka market. If there is an abundance of inventory, prices are depressed.If supplies are scarce, prices soar.
Supply SideWater is the key to the production of corn, which requires about5,000 gallons of water per bushel. During the growing season 18 to24 inches of rain are required to produce 100- to 175-bushel yields.For every pound of dry matter (leaves, stalks, ears, etc.) produced,372 pounds of water are needed. Normal rainfall during the growing season provides only half of the needed moisture. Therefore,subsoil moisture is critical.Water can be a problem at planting time and at harvest. In Iowaand other Midwestern states, wet fields in the spring can delayplanting. If planting is substantially delayed, farmers may switch tosoybeans. Heavy rain at harvest can knock down stalks, slow harvest, and reduce yields. There’s usually no such thing as a “normal”year. Either you get too much or too little rain.One of the most critical periods occurs when the plant pollinates—usually for about 10 days around mid- to late July in theCorn Belt. During this period, corn needs moisture—either rainfallor subsoil. Additionally, the temperature cannot be excessively high.
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A week of 100-degree-plus temperatures during pollination substantially reduces yields.
Demand SideAbout 80 percent of the U.S. corn crop is used domestically, consumed as feed for livestock, for human food, for alcohol, and forseed. Livestock feed is by far the most important. Alcohol usage hasbeen boosted in recent years as ethanol has become popular as afuel blend to enhance octane and as an oxygenate to reduce air pollution.Domestic and overseas livestock industries consume about 80percent of all corn grown in the United States, feeding it as groundgrain, silage, high-oil, and high-moisture corn, according to the National Corn Growers Association.From just over 10 million gallons of production in 1979, the U.S.fuel ethanol industry has grown to more than 1.8 billion gallons ofannual production capacity. The USDA estimates that ethanol production uses about 500 million bushels of corn a year, and projectsa 1.7 percent average growth rate during the next 5 years.Demand depends quite a bit on the financial conditions of livestock producers and the cattle cycle. Are animal numbers increasing or decreasing? Are herds expanding or contracting? Demand forfeed can be estimated when you can get a good fix on these numbers.The price of wheat must