Futures For You
| INSIDE THE FUTURES
WORLD
Want to learn how the futures markets really work? Carley Garner, senior analyst for Alaron who also writes the company's Dow/NASDAQ Report and the Bond Report newsletters, reponds to your questions about today's futures markets. To submit a question, post your question to our website at https://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C. |
Carley Garner |
WHY TRADE FUTURES?
Many beginning commodity traders are migrants from the world of stock trading, but before making the transition they often ask why they should trade futures. The answer is simple, but the decision to move forward isn't.
No interest on leverage: The futures market is a convenient venue for speculators in that the leverage is high and the ability to buy or sell in any order is abundant. Unlike equity traders who must borrow shares of stock from their brokerage firm before short-selling and are then subject to interest charges, futures traders can sell something they have never owned and buy it back at some point in the future -- hopefully at a lower price.
Favorable tax treatment and convenient accounting: Another advantage to trading futures as opposed to stocks is the tax treatment of gains and losses. A futures trader doesn't have to report each and every individual trade to the IRS, which stock traders must do. In addition, stock trades are subject to being categorized as either long-term or short-term capital gains or losses. Naturally, the long-term gains are taxed at a discounted rate, while short-term gains are taxed at a higher level. Futures traders enjoy an automatic 40/60 blend when it comes to tax treatment. All profits and losses in the futures markets are subject to be taxed using the blend of 60% long term and 40% short term. Most trades, not investments (there is a difference), don't last more than the 12 months required to be classified as long term. Thus, futures traders are benefiting from favorable long-term tax rates despite being short-term traders.
Leverage: The most talked-about advantage to trading futures over stock trading is "free" leverage. Stock traders can leverage trades by borrowing money or shares from their brokerage firms and compensating them through interest paid on amounts borrowed, but futures traders are automatically granted leverage by the exchanges without interest charges ever being incurred.
Are futures for you? With all of these advantages, why wouldn't everyone trade futures? The truth is, commodity trading isn't for everyone. Along with the potential rewards come substantial risks. Only those with nerves of steel, the willingness to accept theoretically unlimited risk, and the financial capacity to do so should even consider participating in these treacherous markets.
I don't own a crystal ball (not one that works, anyway), but I do have access to charts and have formed a strong inclination that the grains may have run their course for the time being. With prices at or near all-time highs, I am likely not the only one who is bearish corn, beans, or wheat -- and that may be part of the problem. Some of the rally may be attributed to the short-covering of fickle bears.
The one thing we all know about commodities is that they are goods, and their value can't drop to zero. In theory, however, the sky is the limit on the upside -- or is it? Commodities, like many other aspects of the economy, are cyclical in nature and often shift between periods of inflated prices and those of discounted prices. Commodities, unlike stocks, tend to trade in a defined range as opposed to forging consistent gains. This is a simple function of supply and demand. As commodities become more expensive, farmers will work hard to plant more and bring product to the marketplace. Obviously, this doesn't happen overnight, but in the world of grains the situation can be drastically improved in as little as a year.
Seasonals? They didn't really have an impact on trade in 2007; during times that grains normally trade weaker we saw the opposite, and vice versa. Overall, both soybeans and corn are relatively bullish from January through May, but with prices already significantly elevated at year's end, there doesn't seem to be much room on the upside.
The all-time high in soybeans occurred in the 1970s and is said to have been at $12.90 for the front month. At the time this column was written, March soybeans were trading near $12.40. If further advances are made, it seems as though traders will have a hard time finding the motivation to bid prices much above the previous all-time high. In the case of corn, the hurdle will be the 1996 rally to about $5.56. March corn was valued at about $4.60 coming into 2008. As you can see, on a percentage basis, corn prices are relatively distant to the all time high when compared to soybeans.
Nonetheless, each of these markets are due for a significant correction, but timing is everything and it is important that you are using a trading strategy that will allow you to stay in the game, should your entry point be off the mark a bit.
Soybeans have spiked above $10 a handful of times in the past, but never
managed to hold such elevated prices. Will this time be different? Only
time will tell -- but in trading it is imperative that you put the odds
in your favor, and betting against history seems to be doing just the opposite.
Originally published in the March 2008 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2008, Technical Analysis, Inc.
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