Q&A
Futures For You
Inside The Futures World
Want to find out how the futures markets really work?
DeCarley Trading senior analyst and broker Carley Garner 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.
CONTANGO!
In futures industry language, what does “contango” mean?
Commentators often use contango in reference to the commodity markets because it sounds exciting. The true meaning of the word is less than thrilling; in fact, it is downright normal. Contango is a scenario in which spot (current delivery) commodity prices are trading at a discount to prices displayed in the futures markets (future delivery).
To fully understand the word’s meaning, you must recognize what causes such a price relationship. There are essentially two separate, yet related, markets in which commodities are traded: the cash market and the futures market. The cash market refers to buying and selling of the physical commodities; the price and the product exchange occurs in the present. On the other hand, the futures market deals with buying or selling of future obligations to make or take delivery of a commodity. In general, speculators find the futures market a more efficient means of facilitating trades. A futures trader can speculate on the price of corn (not an artificially indexed tradable, like an exchange traded fund) without transporting, storing, or even seeing the underlying commodity.
Because of variations in the timing of the commodity’s exchange, prices at which commodities trade in the cash and futures markets differ from one another. After all, if a commodity is going to be delivered at some point in the future (as opposed to now), it must be stored and insured in the meantime. Such expenses are known as the “cost to carry” and in normal market conditions cause the cash price of a particular commodity to be cheaper than the futures price. Similarly, a futures contract expiring in a near month will typically trade at a lower price than a futures contract with a relatively distant expiration date. A commodity market that displays such progressive pricing is referred to as a “normal carry charge market” — or one in contango.
The opposite of contango is backwardation. This sometimes occurs during times of tight supply in the cash market severe enough to cause spot prices to trade at a higher price than futures.
CALCULATING LEVELS
How can I calculate the size or length of levels in stocks, futures, and forex?
I am going to assume we are referring to areas of support & resistance. Unfortunately, as in most subjects pertaining to the markets, there is no simple answer; trading is an art, not a science, and therefore most measures of critical levels are subjective. What one trader looks at as a strong resistance point and reason to sell, another might declare a potential market breakout. This is what makes the markets.
One popular method of anticipating support and resistance is the Fibonacci ruler. The technical tool is based on the number sequence and corresponding ratios developed by the 13th-century mathematician known as Fibonacci. According to Fibonacci, the markets move in conjunction with what is referred to as the “golden ratio.” Some technical analysts believe that support and resistance levels can be found near the 23.6%, 38.2%, 50%, 61.8%, 76.4%, and 100% retracement areas of price moves.
The Fibonacci ruler is best used in conjunction with major peaks and troughs. For instance, using a continuous monthly chart of the S&P futures, the market peaked in October 2007 near 1590 and found a low in March 2008 near 670. Therefore, the 23.6%, 38.2%, 50%, 61.8%, and 76.4% retracement levels are 893, 1027, 1135, 1244, and 1378, respectively. A 100% retracement would occur if the market returned to its prebear market level near 1590. In theory, each of these prices should offer resistance on the way up and if penetrated becomes the market support, but if you draw enough lines on a chart, the market is bound to bounce off of one of them. A better example of this might be the Gann fan.
Chartist W.D. Gann believed that support and resistance levels could be predicted using geometry. The Gann fan is based on nine angles derived from the premise that the ideal balance between time and price occurs when the prices rise and fall at a 45-degree angle relative to the time axis. Although it is true that a Gann fan overlaying a price chart will almost always produce the appearance of the market finding support and resistance on each of the nine lines, you might get the same result by randomly drawing lines on a chart.
I don’t mean to discourage you from using these or any other charting tool or indicator to determine support and resistance levels, but I need to point out that determining where support and resistance will be is a relatively arbitrary process. I have had more success in discovering key market levels by simply drawing trendlines and market channels. After all, true resistance is the price at which buyers become reluctant to enter fresh long positions and bears feel as though they have an edge being short. No mathematical tool can predict human behavior, and only the market can tell you what this price is (eventually). For that reason, it is logical to use historical market tendencies to attempt to predict what might happen next as opposed to geometry.
That said, this opinion is based on my personality and experience. The bottom line is that you have to find what works for you, not somebody else!