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A Complete Guide to the Futures Market, 2E


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Table of Contents

About the Authors xv Part I Preliminaries Chapter 1 For Beginners Only 3 Purpose of This Chapter 3 The Nature of Futures Markets 3 Delivery 4 Contract Specifications 5 Volume and Open Interest 9 Hedging 11 Trading 15 Types of Orders 16 Commissions and Margins 19 Tax Considerations 19 Chapter 2 The Great Fundamental versus Technical Analysis Debate 21 Part II Chart Analysis and Technical Indicators Chapter 3 Charts: Forecasting Tool or Folklore? 27 Chapter 4 Types of Charts 35 Bar Charts 35 Linked Contract Series: Nearest Futures versus Continuous Futures 39 Close-Only ("Line") Charts 40 Point-and-Figure Charts 42 Candlestick Charts 43 Chapter 5 Linking Contracts for Long-Term Chart Analysis: Nearest versus Continuous Futures 45 The Necessity of Linked-Contract Charts 45 Methods of Creating Linked-Contract Charts 46 Nearest versus Continuous Futures in Chart Analysis 48 Conclusion 51 Chapter 6 Trends 57 Defining Trends by Highs and Lows 57 TD Lines 66 Internal Trend Lines 73 Moving Averages 78 Chapter 7 Trading Ranges 83 Trading Ranges: Trading Considerations 83 Trading Range Breakouts 86 Chapter 8 Support and Resistance 91 Nearest Futures or Continuous Futures? 91 Trading Ranges 92 Prior Major Highs and Lows 94 Concentrations of Relative Highs and Relative Lows 101 Trend Lines, Channels, and Internal Trend Lines 106 Price Envelope Bands 107 Chapter 9 Chart Patterns 109 One-Day Patterns 109 Continuation Patterns 122 Top and Bottom Formations 134 Chapter 10 Is Chart Analysis Still Valid? 149 Chapter 11 Technical Indicators 155 What Is an Indicator? 155 The Basic Indicator Calculations 157 Comparing Indicators 157 Moving Average Types 165 Oscillators and Trading Signals 167 Indicator Myths 170 Indicator "Types" 172 Conclusion 173 Part III Applying Chart Analysis to Trading Chapter 12 Midtrend Entry and Pyramiding 177 Chapter 13 Choosing Stop-Loss Points 183 Chapter 14 Setting Objectives and Other Position Exit Criteria 189 Chart-Based Objectives 189 Measured Move 190 Rule of Seven 194 Support and Resistance Levels 196 Overbought/Oversold Indicators 198 DeMark Sequential 199 Contrary Opinion 203 Trailing Stops 204 Change of Market Opinion 204 Chapter 15 The Most Important Rule in Chart Analysis 205 Failed Signals 205 Bull and Bear Traps 205 False Trend Line Breakouts 211 Return to Spike Extremes 213 Return to Wide-Ranging Day Extremes 216 Counter-to-Anticipated Breakout of Flag or Pennant 219 Opposite Direction Breakout of Flag or Pennant Following a Normal Breakout 222 Penetration of Top and Bottom Formations 225 Breaking of Curvature 229 The Future Reliability of Failed Signals 229 Conclusion 231 Part IV Trading Systems and Performance Measurement Chapter 16 Technical Trading Systems: Structure and Design 235 The Benefits of a Mechanical Trading System 236 Three Basic Types of Systems 236 Trend-Following Systems 237 Ten Common Problems with Standard Trend-Following Systems 244 Possible Modifications for Basic Trend-Following Systems 247 Countertrend Systems 254 Diversification 256 Ten Common Problems with Trend-Following Systems Revisited 259 Chapter 17 Examples of Original Trading Systems 261 Wide-Ranging-Day System 261 Run-Day Breakout System 268 Run-Day Consecutive Count System 273 Conclusion 278 Chapter 18 Selecting the Best Futures Price Series for System Testing 279 Actual Contract Series 279 Nearest Futures 280 Constant-Forward ("Perpetual") Series 281 Continuous (Spread-Adjusted) Price Series 282 Comparing the Series 285 Conclusion 287 Chapter 19 Testing and Optimizing Trading Systems 289 The Well-Chosen Example 289 Basic Concepts and Definitions 291 Choosing the Price Series 293 Choosing the Time Period 293 Realistic Assumptions 295 Optimizing Systems 297 The Optimization Myth 298 Testing versus Fitting 310 The Truth about Simulated Results 312 Multimarket System Testing 313 Negative Results 314 Ten Steps in Constructing and Testing a Trading System 315 Observations about Trading Systems 316 Chapter 20 How to Evaluate Past Performance 319 Why Return Alone Is Meaningless 319 Risk-Adjusted Return Measures 323 Visual Performance Evaluation 335 Investment Insights 343 Part V Fundamental Analysis Chapter 21 Fourteen Popular Fallacies, or What Not to Do Wrong 347 Five Short Scenes 347 The Fourteen Fallacies 349 Chapter 22 Supply-Demand Analysis: Basic Economic Theory 359 Supply and Demand Defined 359 The Problem of Quantifying Demand 362 Understanding the Difference between Consumption and Demand 363 The Need to Incorporate Demand 366 Possible Methods for Incorporating Demand 368 Why Traditional Fundamental Analysis Doesn't Work in the Gold Market 371 Chapter 23 Types of Fundamental Analysis 373 The "Old Hand" Approach 373 The Balance Table 373 The Analogous Season Method 374 Regression Analysis 375 Index Models 376 Chapter 24 The Role of Expectations 379 Using Prior-Year Estimates Rather Than Revised Statistics 379 Adding Expectations as a Variable in the Price-Forecasting Model 380 The Influence of Expectations on Actual Statistics 380 Defining New-Crop Expectations 381 Chapter 25 Incorporating Inflation 383 Chapter 26 Seasonal Analysis 389 The Concept of Seasonal Trading 389 Cash versus Futures Price Seasonality 389 The Role of Expectations 390 Is It Real or Is It Probability? 390 Calculating a Seasonal Index 391 Chapter 27 Analyzing Market Response 403 Evaluating Market Response for Repetitive Events 403 Chapter 28 Building a Forecasting Model: A Step-by-Step Approach 413 Chapter 29 Fundamental Analysis and Trading 417 Fundamental versus Technical Analysis: A Greater Need for Caution 417 Three Major Pitfalls in Fundamental Analysis 418 Combining Fundamental Analysis with Technical Analysis and Money Management 426 Why Bother with Fundamentals? 427 Are Fundamentals Instantaneously Discounted? 428 Fitting the News to Price Moves 431 Fundamental Developments: Long-Term Implications versus Short-Term Response 432 Summary 435 Part VI Futures Spreads and Options Chapter 30 The Concepts and Mechanics of Spread Trading 439 Introduction 439 Spreads-Definition and Basic Concepts 440 Why Trade Spreads? 440 Types of Spreads 441 The General Rule 443 The General Rule-Applicability and Nonapplicability 443 Spread Rather Than Outright-An Example 445 The Limited-Risk Spread 446 The Spread Trade-Analysis and Approach 448 Pitfalls and Points of Caution 449 Chapter 31 Intercommodity Spreads: Determining Contract Ratios 453 Chapter 32 Spread Trading in Stock Index Futures 461 Intramarket Stock Index Spreads 461 Intermarket Stock Index Spreads 462 Chapter 33 Spread Trading in Currency Futures 471 Intercurrency Spreads 471 Intracurrency Spreads 473 Chapter 34 An Introduction to Options on Futures 477 Preliminaries 477 Factors That Determine Option Premiums 480 Theoretical versus Actual Option Premiums 483 Delta (the Neutral Hedge Ratio) 484 Chapter 35 Option Trading Strategies 487 Comparing Trading Strategies 487 Profit/Loss Profiles for Key Trading Strategies 489 Part VII Practical Trading Guidelines Chapter 36 The Planned Trading Approach 559 Step 1: Define a Trading Philosophy 559 Step 2: Choose Markets to Be Traded 560 Step 3: Specify Risk Control Plan 560 Step 4: Establish a Planning Time Routine 563 Step 5: Maintain a Trader's Spreadsheet 563 Step 6: Maintain a Trader's Diary 565 Step 7: Analyze Personal Trading 565 Chapter 37 Seventy-Five Trading Rules and Market Observations 567 Entering Trades 568 Exiting Trades and Risk Control (Money Management) 569 Other Risk-Control (Money Management) Rules 570 Holding and Exiting Winning Trades 570 Miscellaneous Principles and Rules 571 Market Patterns 572 Analysis and Review 573 Chapter 38 50 Market Wizard Lessons 575 Appendix A Introduction to Regression Analysis 589 Basics 589 Meaning of Best Fit 591 A Practical Example 593 Reliability of the Regression Forecast 593 Appendix B A Review of Elementary Statistics 597 Measures of Dispersion 597 Probability Distributions 599 Reading the Normal Curve (Z) Table 604 Populations and Samples 606 Estimating the Population Mean and Standard Deviation from the Sample Statistics 607 Sampling Distribution 608 Central Limit Theorem 609 Standard Error of the Mean 612 Confidence Intervals 612 The t-Test 614 Appendix C Checking the Significance of the Regression Equation 619 The Population Regression Line 619 Basic Assumptions of Regression Analysis 620 Testing the Significance of the Regression Coefficients 620 Standard Error of the Regression 627 Confidence Interval for an Individual Forecast 627 Extrapolation 630 Coefficient of Determination (r2) 630 Spurious ("Nonsense") Correlations 634 Appendix D The Multiple Regression Model 637 Basics of Multiple Regression 637 Applying the t-Test in the Multiple Regression Model 640 Standard Error of the Regression 641 Confidence Intervals for an Individual Forecast 642 R2 and Corrected R2 642 F-Test 643 Analyzing a Regression Run 644 Appendix E Analyzing the Regression Equation 649 Outliers 649 The Residual Plot 650 Autocorrelation Defined 651 The Durbin-Watson Statistic as a Measure of Autocorrelation 651 The Implications of Autocorrelation 654 Missing Variables and Time Trend 655 Dummy Variables 658 Multicollinearity 663 Addendum: Advanced Topics 666 Appendix F Practical Considerations in Applying Regression Analysis 673 Determining the Dependent Variable 673 Selecting the Independent Variables 675 Should the Preforecast Period Price Be Included? 675 Choosing the Length of the Survey Period 676 Sources of Forecast Error 677 Simulation 678 Stepwise Regression 679 Sample Step-by-Step Regression Procedure 680 Summary 681 References and Recommended Readings 683 Index 685

About the Author

JACK D. SCHWAGER is a co-founder of FundSeeder, a web-based technology and investment business designed to connect undiscovered trading talent with sources of investment capital. He is the author of numerous acclaimed financial books, including the Market Wizards series and Market Sense and Nonsense. MARK ETZKORN is founder of FinCom Media. He was formerly Editor-in-Chief of Active Trader magazine, editor at Futures magazine, and a member of the Chicago Mercantile Exchange. He has authored, edited, and contributed to more than 10 books on the financial markets.

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