The Complete Guide to Futures Trading What You Need to Know About the Risks and Rewards
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The Complete Guide to Futures Trading What You Need to Know about the Risks and Rewards REFCO PRIVATE CLIENT GROUP John Wiley & Sons, Inc. The Complete Guide to Futures Trading The Complete Guide to Futures Trading What You Need to Know about the Risks and Rewards REFCO PRIVATE CLIENT GROUP John Wiley & Sons, Inc. Copyright © 2005 by Refco Private Client Group. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400, fax 978-646-8600, or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201-748-6011, fax 201-748-6008, or online at www.wiley.com/go/permissions. Limit of Liability/Disclaimer of Warranty: While the publisher and the author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor the author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. FUTURES TRADING INVOLVES THE SUBSTANTIAL RISK OF LOSS AND IS NOT SUITABLE FOR ALL INVESTORS. Designations used by companies to distinguish their products are often claimed by trademarks. In all instances where the author or publisher is aware of a claim, the product names appear in Initial Capital letters. Readers, however, should contact the appropriate companies for more complete information regarding trademarks and registration. For general information about our other products and services, please contact our Customer Care Department within the United States at 800-762-2974, outside the United States at 317-572-3993 or fax 317-572-4002. Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at www.wiley.com. Library of Congress Cataloging-in-Publication Data: The complete guide to futures trading : what you need to know about the risks and rewards. p. cm. “The author is under a company’s name: Refco Private Client Group.” ISBN-13 978-0-471-48802-6 (pbk.) ISBN-10 0-471-48802-X (pbk.) 1. Financial futures. I. Refco Private Client Group. HG6024.3.C67 2005 332.64'52—dc22 2005003024 Printed in the United States of America. 10987654321 Contents Foreword ix Preface xi About the Contributors xiii CHAPTER 1 Futures: The Investment for the Twenty-First Century 1 Mark Sachs Historical Roots 2 What Futures Are 2 What Futures Are Not 4 Who Trades Futures? 9 Making Your Choice 11 CHAPTER 2 Becoming a Futures Trader 13 Dan McMullin Trading Decision Issues 14 Fundamental Analysis Highlights 18 Technical Analysis Highlights 25 Putting It All Together 56 CHAPTER 3 Trading with a Broker as a Partner 59 Jim Gombas What a Broker Can Offer 59 Options versus Futures 65 Market Should Fit Strategy 66 Paper Trading, Back-Testing 67 CHAPTER 4 Letting the Pros Trade Your Account 69 Carol Dannenhauer Why Managed Futures? 70 Where Do You Start? 74 v vi CONTENTS Evaluating Trading Programs 76 Investing in Managed Futures 80 CHAPTER 5 Using an Auto-Executing Trading System 83 Herb Kral Why an Auto-Executing Trading System? 83 Look at Yourself First 85 What to Look for in a Trading System 86 Why “Successful” Systems May Fail 88 Summing up Systems 89 CHAPTER 6 Resources for the Self-Directed Trader 91 David Howe Brokerage Firm Choice 91 Trading Platform 93 Trading Support Tools 95 Match Resources to Your Needs 98 CHAPTER 7 Knowing Your Margins and Marching Orders 99 Greg Gulotta Trading on Margin 99 Order Types 101 Placing Orders 108 Tips about Trading Mechanics 110 Connectivity Issues and Questions 113 CHAPTER 8 Futures: Diverse Markets You Can Trade 115 Susan Abbott Gidel Equity-Based Futures 117 Financial Instruments 122 Commodities 127 CHAPTER 9 Options on Futures: A Flexible Trading Tool 139 Dan McMullin Issues to Consider When Investing in Futures Options 140 Mechanics of Futures Options 144 Basic Futures Options Strategies 151 Contents vii CHAPTER 10 Forex: Another Opportunity for Traders 167 Phillip Fondren What Is the Forex Market? 167 Exchange Rates and Central Banks 171 The Trading Instrument 172 Spot Market versus Futures Market 176 Electronic Trading 177 Costs of Trading 178 CHAPTER 11 Deciding to Trade 181 Mark Sachs The Money Factor 181 Time for Trading 183 Knowing the Market 183 Who Are You? 183 Your Trading Plan 184 Picking a Brokerage Firm 186 CHAPTER 12 Opening an Account 189 Nancy Westwick Opening Account Information 190 Risk Disclosures 190 Type of Account 192 Power of Attorney 193 Customer Identification (Patriot Act Requirements) 193 Single-Stock Futures 193 Account Funding Requirements 194 Margin Calls 194 Resolving Disputes 195 CHAPTER 13 The Tax Factor for Traders 197 Philip Silverman Section 1256 Contracts 197 How to Report Gains or Losses 199 Special Considerations 201 viii CONTENTS CHAPTER 14 The Business of Futures: Who Does What 203 Laura Oatney Regulatory Structure 203 Futures Exchanges 205 Clearinghouses 205 Futures Industry Professionals 207 APPENDIX A Domestic and International Futures Contract Volume 211 APPENDIX B Futures Contract Specifications 251 APPENDIX C Speculative Margins 269 Glossary 273 Index 289 Foreword As its title suggests, this landmark book makes futures trading accessible to main- stream individual investors. The determination of whether futures are right for your portfolio remains with each individual, but The Complete Guide to Futures Trading can serve as an expert advisor to help you make informed decisions about how to participate in the exciting derivatives markets. Written by experienced practitioners from Refco, a diversified global financial services organization, and Refco Private Client Group, previously known as Lind- Waldock, a leading broker for individual futures traders, the book answers the questions a newcomer to futures and commodities trading might have about what it takes to establish an account and make a commitment to trading. This is not a book about trading futures, however. It does not offer tips about a particular technical or fundamental approach to the markets. Instead, it serves as a bridge between having an interest in futures—yet knowing little about how to go about acting on that interest—and placing a trading order in your futures ac- count. After reading it, you will know what questions to ask yourself and your bro- kers and other industry professionals when getting ready to establish a futures trading account. Readers who are new to futures trading will be interested in the range of top- ics covered, because it will answer questions about how to get started trading commodity futures: • Which type of account is best for me? • What should I know about risk, leverage, and margin? • Is my comfort level with risk in line with what futures trading provides? • What questions should I ask when looking for a brokerage relationship? • How are futures taxed? • What resources do I need as a futures trader? • What are the different ways to approach making a trading decision? • What are the various types of orders I can use? • What markets can I trade? Clearly written by contributors with a depth of practical understanding that comes from years in the futures industry, The Complete Guide to Futures Trading ix x FOREWORD addresses these issues and others in a well-organized, easy-to-follow style. As chief executive officer of the largest financial exchange in the world for trading fu- tures and options, I can wholeheartedly recommend this volume for the reader who wants to learn the fundamentals of investing in futures. CRAIG S. DONOHUE Chief Executive Officer Chicago Mercantile Exchange May 2005 CME is the largest financial exchange in the world for trading futures and op- tions on futures—serving risk-management needs globally through a diverse range of derivatives products on its CME® Globex® electronic trading platform as well as on its trading floors. Today the company is in 27 countries, with more than 740 direct customer connections, annual sales in excess of $735 mil- lion, and 1,300 employees. In 2004, CME handled nearly 800 million contracts with an underlying value of $463 trillion. The first financial exchange in the United States to go public, CME is traded on the New York Stock Exchange and Nasdaq under the symbol “CME” and has a market value of nearly $7 billion. Preface utures are the investment of the twenty-first century. At the beginning of the twentieth century, investing in stocks was consid- F ered a risky proposition for individuals, who were advised to stick to buying bonds. Now, over 50 percent of U.S. households invest in the stock market directly or indirectly through mutual fund holdings—even in retirement accounts. At Refco Private Client Group, we believe writers of the twenty-second century looking back on the twenty-first will say the same about investment in futures.