Futures For You
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WORLD
Want to find out how the futures markets really work? Carley Garner, a senior analyst for Alaron who also writes the company's Dow/NASDAQ Report and the Bond Report newsletters, responds to your questions about today's futures markets. To submit a question, post your question 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 |
Is gold really a safe haven?
When the term "safe haven" is casually used to describe the precious metals markets, namely gold, I cringe. I find myself wondering, safe relative to what? In my experience, gold futures have proven to be on the top of the list of volatile commodities. Sure, if you are savvy enough to buy the low and sell the high, investing in gold is safe. For those of us who can't see into the future, buying or selling gold in the futures, cash, or bullion market is purely speculation. My intent isn't to discourage you from trading gold, but to make sure that you see it for what it is -- a trade and not an investment.
This belief may stem from the days when gold was viewed as an asset, not a currency, or subsequently in the gold standard era. However, the argument for safe gold doesn't seem to have much validity in today's markets. Gold market fundamentals today are a far cry from what they were in the past, yet many seem to have overlooked this fact.
It is easy to convince yourself that a commodity that has tripled in value since 2003 is a safe play, but the trend is only your friend until it ends. Once it does, it becomes the wicked stepmother. Imagine if you bought gold near $1,000 per troy ounce just a few short months ago. Had you done so, you would have watched what you assumed was a safe investment lose nearly 15% of its value in the six weeks following. If we were talking bullion, you would be lucky because it isn't leveraged. Had you bought a futures contract, you would be out $15,000 on one futures contract with the market at $850. My idea of a safe-haven investment is short-term Treasury notes or bills in which the principal and interest are guaranteed, not a market that has the ability to make me cry myself to sleep at night.
Can I use stock index futures to hedge my stock portfolio?
Yes! The primary function of the futures markets is commercial hedging despite the fact that speculators make up most of the volume and open interest. Nevertheless, individual investors can use the futures market as a means of hedging their diversified stock and bond portfolios. Unless you are only holding an exchange traded fund (ETF) that mimics the Standard & Poor's 500, the odds for a perfect hedge are astronomical, but the potential for a partial hedge is good.
Before you practice such a strategy, it is important to realize that a hedge, by definition, reduces or eliminates risk but involves an opportunity cost. I am often approached by those looking for me to devise a strategy that will allow them to eliminate price risk without any consequences. This is impossible.
To illustrate, somebody holding $350,000 in diversified stock holdings or mutual funds could sell one full-sized S&P futures contract in order to reduce the risk of an equity market correction. This assumes that the S&P is valued at 1400 (1400 x $250). As the stock market drops, the short futures position will gain in value while the stock portfolio would lose value. The gains and losses wouldn't perfectly offset each other, but it would certainly allow you to sleep better through a downturn. If you are interested in hedging a smaller amount, you could do so using a miniS&P contract. Once again, assuming an index value of 1400, selling one contract would hedge $70,000 in well-diversified stock holdings.
On the contrary, if the hedge is initiated and the stock market rallies, the investor will be gaining on the diversified stock portfolio and losing on the short futures position that was intended to protect stock holdings. In essence, the trader would be giving up all of the gains forged post-hedge execution, and as you can imagine, that can be frustrating. Reasons like this often prompt investors to partly hedge their holdings or simply buy puts to ensure against a portfolio-smashing market move as opposed to a full-fledged hedge.
That said, note that doing this may result in many put options expiring worthless before the strategy provides any protection to your portfolio. It is like buying car insurance. You pay premiums month after month to protect yourself against catastrophe, but there is a chance that most of the monies you pay will never be repaid to you through filed claims.
Which is the best indicator or oscillator?
There isn't a right or wrong answer. The best trading tool is the one that will make you money. Which indicator or oscillator that is may depend on your trading strategy, personality, or risk tolerance.
Most oscillators will provide the similar performance results over the long run if followed blindly. Some are quicker to trigger buy or sell signals, but they are all indicators of where the market has been, not necessarily where it is going, although that is how we interpret them.
I prefer to use Bollinger bands simply because they are based on standard deviations and the corresponding statistics involved. Keep in mind, being a successful trader boils down to putting the odds in your favor. Using a tool capable of defining an envelope in which the market will, in theory, trade within roughly 96% of the time is powerful.
Originally published in the August 2008 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2008, Technical Analysis, Inc.
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