american futures trading

How Open Outcry Works in American Futures Trading ?

Around the world, most futures exchanges now use electronic trading. The United States still uses the open outcry system of futures trading for many physical commodities, such as agricultural and oil. However, most U.S. futures markets also offer electronic trading.

In the open outcry system, here’s how a trade takes place:

When you call your broker, he relays a message to the trading floor, where a runner relays the message to the floor broker, who then executes the trade. The runner then relays the trade confirmation back to your broker, who tells you how it went.

Trade reporters on the floor of the exchange watch for executed trades, record them, and transmit these transactions to the exchange, which, in turn, transmits the price to the entire world almost simultaneously.

The order of business is similar when you trade futures online, except that you receive a trade confirmation via an e-mail or other online communiqué.

One key difference between open outcry and electronic trading is the length of the trading day. Regular market hours usually run from 8:30 a.m. to 4:15 p.m. eastern time. Globex, the major electronic data and trading system, extends futures trading beyond the pits and into an electronic overnight session. Globex is active 23 hours per day.

When you turn to the financial news on CNBC before the stock market opens, you see quotes for the S&P 500 futures and others taken from Globex as traders from around the world make electronic trades. Globex quotes are real, meaning that if you keep a position open overnight, and you place a sell stop under it or you place a buy order with instructions to execute in Globex, you may wake up the next morning with a new position, or out of a position altogether.

Globex trading overnight tends to be thinner than trading during regular market hours. It’s also more volatile in some ways than trading during regular hours.

Risks with Investing in Commodities

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Investing is all about managing the risk involved in generating returns. Here are some common risks you face when investing in commodities and some small steps you can take to minimize these risks.

Geopolitical risk with commodities investments

One of the inherent risks of commodities is that the world’s natural resources are located in various continents and the jurisdiction over these commodities lies with sovereign governments, international companies, and many other entities. For example, to access the large deposits of oil located in the Persian Gulf region, oil companies have to deal with the sovereign countries of the Middle East that have jurisdiction over this oil.

International disagreements over the control of natural resources are quite commonplace. Sometimes a host country will simply kick out foreign companies involved in the production and distribution of the country’s natural resources.

So how do you protect yourself from this geopolitical uncertainty? One way to minimize it is to invest in companies with experience and economies of scale. For example, if you’re interested in investing in an international oil company, go with one with an established international track record.

A company like ExxonMobil, for instance, has the scale, breadth, and experience in international markets to manage the geopolitical risk they face. A smaller company without this sort of experience is going to be more at risk than a bigger one. In commodities, size does matter.

What Are Commodities Exchange Traded Funds All About?

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Many financial institutions are now offering commodities Exchange Traded Funds, or ETFs. This new breed of ETF enables you to buy into a fund that offers the diversification inherent in a mutual fund, with the added benefit of being able to trade that fund like a regular stock, giving you the powerful combination of diversification and liquidity.

Here is a list of some commodity ETFs:

• United States Oil Fund (AMEX: USO): The Unites States Oil Fund (USO) is an ETF that seeks to mirror the performance of the West Texas Intermediate (WTI) crude oil futures contract on the New York Mercantile Exchange (NYMEX). Although the ETF doesn’t reflect the movement of the WTI contract tick by tick, it does a good job of broadly mirroring its performance.

• streetTRACKS Gold Shares (AMEX: GLD): This ETF seeks to mirror the performance of the price of gold on a daily basis. The fund actually holds physical gold in vaults located in secure locations to provide investors with the ability to get exposure to physical gold without actually holding gold bullion.

• iShares Silver Trust (AMEX: SLV): This is the first ever ETF to track the performance of the price of physical silver. Like the gold ETF, the silver ETF holds actual physical silver in vaults. This is a safe way to invest in the silver markets without going through the futures or physical markets.

Questions to Ask before Investing in Any Commodity

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Whether you decide to invest through futures contracts, managed funds, or commodity companies, you need to gather as much information as possible before you start trading.

The performance of any investment vehicle you choose depends on that commodity's actual fundamental supply and demand story.

Here are a few questions you should ask yourself before you start investing in any commodity:

• Which country/countries hold the largest reserves of the commodity?

• Is that country politically stable or is it vulnerable to turmoil?

• How much of the commodity is actually produced on a regular basis? (Ideally, you want to get data for daily, monthly, quarterly, and annual basis.)

• Which industries/countries are the largest consumers of the commodity?

• What are the primary uses of the commodity?

• Are there any alternatives to the commodity? If so, what are they and do they pose a significant risk to the production value of the target commodity?

• Are there any seasonal factors that affect the commodity?

• What is the correlation between the commodity and comparable commodities in the same category?

• What are the historical production and consumption cycles for the commodity?

Questions to Ask before Investing in Commodity Mutual Funds

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Before you invest in a mutual fund, you should gather as much information as possible about the fund itself, as well as about the mechanics of investing in the fund. You can get answers to these questions directly from the fund manager or the fund’s prospectus.

Here are some useful questions to help you zero in on the key points of mutual fund investing:

• What is the fund’s investment objective? Different funds have radically different investment objectives. While one may focus on capital gains, another may specialize in income investing.

• What securities does the fund invest in? A number of funds claim their main investment products are commodities when in reality only a small percentage of the fund is commodities-related.

• Who manages the fund? You want to know as much as possible about the individuals who are going to be managing your hard-earned money. Most money managers in the United States have to be registered with the National Association of Securities Dealers (NASD). You can get information on the manager’s personal background by checking the FINRA Web site.

• What kind of strategy does the fund use? Some funds follow low-risk, steady income strategies, while others have a more aggressive strategy that uses a lot of leverage. Identifying the fund’s strategy right away is critical.

• What is the profile of the typical investor in this fund? The fund will cater to the profile of its investors, which can be anywhere from highly conservative to extremely aggressive.

• What are the main risks of investing in this fund? Whenever you invest, you take on a certain degree of risk: interest rate risk, credit risk, risk of loss of principal, liquidity risk, hedging risk, and geopolitical risk.

• What is the fund’s track record? Although past performance does not guarantee future results, it’s always important to examine the fund’s track record to get a sense of the kinds of returns the managers have achieved for their investors in the past.

• What is the fund’s after-tax performance? Be sure to pay close attention to after-tax returns when looking at historical performance, because these are a more accurate measure of the fund’s performance — and how much money you get to keep after you pay Uncle Sam.

• What are the fund’s fees and expenses? Fees and expenses are always going to cut into how much money you can get out of the fund. Look for funds that have lower expenses and fees.

• What is the minimum capital an investor must commit? This can range anywhere from $500 to $10,000 or more. The minimum requirement may also vary according to the type of investor. Someone investing for an IRA may have to put up less money up front than someone investing through a brokerage account. Finally, many funds also require minimum incremental amounts after the initial investment amount.

• Are there different classes of shares? Most mutual funds offer more than one class of shares to investors. The different classes are based on a number of factors, including sales charges, deferred sales charges, redemption fees, and investor availability.

• What are the tax implications of investing in this fund? Talk to your accountant in order to determine the tax consequences of any investment you make.

Opening an Account with a Commodity Broker

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To start trading exchange-traded products, you have to open a trading account with a commodity broker who’s licensed to conduct business on behalf of clients at the exchange.

The technical term for a commodity broker is a futures commission merchant (FCM). The FCM is licensed to solicit and execute commodity orders and accept payments for this service.

Before choosing a commodity broker who will handle your account, perform a thorough and comprehensive analysis of its trading platform. You want to get as much information as possible about the firm and its activities. A few things you should consider are firm history, firm clients, licensing information, trading platform, regulatory data, and employee information.

After you select a commodity brokerage firm you’re comfortable with, it’s time to open an account and start trading! You can choose from a number of different brokerage accounts. Most firms will offer you at least two types of accounts, depending on the level of control you want to exercise over the account:

• Self-directed accounts: If you feel confident about your trading abilities, have a good understanding of market fundamentals, and want to get direct access to commodity exchange products, then a self-directed account is for you. In this type of account, also known as a non-discretionary individual account, you call the shots and make all the trading decisions.

  Before you open a self-directed account, talk to a few commodity brokers because each firm offers different account features. Specifically, ask about any minimum capital requirements the firm has (some commodity brokers require that you invest a minimum amount of $10,000 or more), account maintenance fees, and the commission scale the firm uses.

• Managed accounts: In a managed account, you’re essentially transferring the responsibility of making all buying and selling decisions over to a trained professional. This type of account is ideal if you don’t follow the markets on a regular (daily) basis, are unsure about which trading strategy will maximize your returns, or simply don’t have the time to manage a personal account.

  Before you open a managed account, first determine your investment goals, time horizon, and risk tolerance, and find a commodity trading advisor (CTA) who will manage your account based on your personal risk profile. Before contracting with anyone, however, find out about any minimum capital requirements, commissions, or management fees you may face.

Selecting a Commodity Trading Advisor

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If you are trading commodities through a managed account, you need to select a commodity trading advisor (CTA). A CTA is a securities professional who is licensed by the Financial Industry Regulatory Authority (FINRA) and the National Futures Association (NFA) to offer advice on commodities and to accept compensation for investment and management services.

Here are a few important questions to ask when you're looking for a qualified CTA:

• How many years of market experience does he have?

• What is his long-term performance record?

• What is his trading strategy and does it square with your investment goals?

• Does he have any complaints filed against him? (This information is publicly available through the NFA.)

• How many accounts is he currently managing? If the number seems high, your account may not be a high priority for him.

• Does he have a criminal record? If so, find out the details of any arrests or convictions. This information is also available through the NFA.

• Before you select a CTA, perform a rigorous background check. A CTA is required to register with the NFA to transact with the public. You can find out a lot about a CTA by visiting the NFA Web site.

After you perform due diligence on your CTA and feel comfortable with him, you’re ready to turn over trading privileges to him. How do you do that? You sign a power of attorney document, which gives your CTA full trading discretion and complete control over the buying and selling of commodities in your account. That means he makes all the decisions, and you have to live with them.

The main benefit of the managed account is that you get a trained professional managing your investments. The drawback is you can’t blame anyone but yourself if you incur any losses.

Placing Orders at the Commodities Exchange

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Your trading account is your link to the commodity exchange. The broker’s trading platform gives you access to the exchange’s main products, such as futures contracts, options on futures, and other derivative products.

Whether you’re buying a forward contract or engaging in a swap, there are specific entry order procedures you need to follow.

Here is a list of the parameters you need to indicate to place an order at the commodities exchange:

• Action: Indicate whether you are buying or selling.

• Quantity: Specify the number of contracts you’re interested in either buying or selling.

• Time: By definition, commodity futures contracts represent an underlying commodity traded at a specific price for delivery at a specific point in the future. Futures contracts have delivery months, and you must specify the delivery month. Additionally, you should also specify the year because many contracts represent delivery points for periods of up to five years (or more).

• Commodity: This is the underlying commodity that the contract represents. It could be crude oil, gold, or soybeans. Sometimes, it’s also helpful to indicate on which exchange you want to place your order. (This is fairly significant because more and more of the same commodities are being offered on different exchanges. For example, the benchmark WTI crude oil — which used to be traded only on the NYMEX — is now available both on the NYMEX floor and on the ICE electronic exchange.)

• Price: This could be the most important piece of the contract: the price at which you’re willing to buy or sell the contract. Unless you’re placing a market order (which is executed at current market prices), you should indicate the price you want your order to be filled.

• Type of Order: There are a lot of different types of orders, from plain vanilla market orders to more exotic ones such as Fill or Kill (FOK). This is an important piece of the order as this is where you indicate how you want to buy or sell the contract.

• Day or Open Order: Market orders relate to price, while day or open orders relate to how long you want your order to remain open. In a day order, your order expires if it isn’t filled by the end of the trading day. An open order, however, will remain open unless you cancel the order, the order is filled, or the contract expires.