Originally, the stock market was created as a way for companies to raise capital. By exchanging ownership in a company for cash, early business ventures were able to raise capital to buy equipment or build factories. Companies hundreds of years ago, as well as today, primarily use the stock market as a means to raise capital.
The modern futures market evolved not from a need to raise capital, but from a need to transfer risk. The futures market makes it possible for those who want to manage price risk (hedgers) to transfer that risk to those who are willing to accept it in the hopes of a profit (speculators).
Futures markets are first and foremost a risk transference vehicle. They also provide price information that the world looks to as a benchmark in determining the value of a particular commodity or financial instrument on any given day or at any specific time of the day. These benefits, risk transference, and price discovery reach every sector of the world economy where changing market conditions create economic risk in the diverse fields of agricultural products, foreign exchange, imports, exports, financing, and investment vehicles.
Futures contracts are standardized to meet the specific requirements of buyers and sellers for a variety of commodities and financial instruments. Quantity, quality, and delivery locations are pre-established. The only variable is price, which is discovered through an auction-like process on the trading floor of an organized futures exchange.
Example
An individual buys one contract of March Corn at $2.25 per bushel on January 2nd, initiating a long position. This contract calls for the delivery of 5,000 bushels of Number 2 Yellow Corn seven days before the last business day of the delivery month (March) at an exchange-recognized facility. If the purchaser of the March Corn contract wishes to exit his position on February 15th, he can do so by selling one March Corn contract.
Assuming that the contract was sold at $2.45 per bushel, the holder of the March Corn contract would receive $1,000.00 (before broker commissions and fees) for holding the position for six weeks:
Profit or Loss = Sale Price – Purchase Price x # of bushels ($2.45 - $2.25 = $0.20 x 5,000 = $1,000.00)
The person in this example is $1,000.00 richer for the experience, and has no further obligation in the Corn market because the sale of the March Corn futures contract at $2.45 per bushel offset the earlier purchase at $2.25 per bushel.
Notice in the previous example that all of the features of the contract were predetermined by the exchange, except the price:
Because futures contracts are standardized (with price as the only variable), buyers and sellers are able to exchange one contract for another and actually offset their obligation to deliver or take delivery of the commodity underlying the futures contract. Offset means to take an equal and opposite position in the futures market to one’s initial position.
The exchanges and their members are able to guarantee all trades because they require all parties in a transaction to deposit performance bond margins. Performance bond margins are financial guarantees required of both buyers and sellers of futures contracts to ensure fulfillment of the contract obligations. That is, buyers and sellers are required to take or make delivery of the commodity or financial instrument represented by the futures contract unless the position is offset before the contract expiration.
Before entering into a transaction, both parties have to post an Initial Margin Requirement. The initial margin requirement is the amount of money a party must have on account with a clearing firm (your broker) at the time the order is placed. Initial margin funds must be on deposit before any trade can be accepted. Maintenance Margin is a set minimum margin (per outstanding futures contract) that a party to a futures contract must maintain in his/her margin account to hold a futures position. Initial margin requirements vary from commodity to commodity, but are generally between 5% and 10% of the total value of the contract.
Example
If March Corn futures are trading at $2.11/bushel, the initial Margin Requirement for CBOT Corn futures is $405.00 per contract, with a maintenance margin requirement of $300.00. Our speculator must have at least $405.00 on deposit with his broker before he could enter the market. He would need to have an account liquidating value of at least $300.00 per contract in order to stay in the position.
Let’s assume that our speculator has $1,000 in his account and decides to buy 2 contracts of March Corn at $2.35/bushel on January 2nd. He is able to buy this because he has more than the initial margin requirement of $810.00 ($405.00 initial margin x 2 contracts = $810.00). With a $50.00 round turn commission rate ($25.00 in and $25.00 out) our speculator’s broker would charge him $50.00 in commissions as well.
If March Corn settled at his entry price of $2.35/bushel, his account liquidating value would be $950.00 ($1,000.00 initial deposit - $50.00 commission) to buy 2 contracts of Corn. Since the liquidating value of the speculator's account (funds on deposit + open position profit or loss) is greater than the maintenance margin requirement of $300.00 per contract or $600.00 for 2 March Corn, he is able to stay in the trade.
The next day, much to our speculator's detriment, Corn prices drop by 5 cents. Our speculator now has an open position loss of -$500.00 and an account liquidating value of $450.00 ($1,000.00 - $50.00 commission - $500.00 open position loss = $450.00). Since this value is less than the Maintenance Margin requirement of $300.00 per contract, or $600.00, our speculator is on a Margin Call.
In order to keep the position, the speculator must either send enough money to bring the account back above the Initial Margin Requirement of $810.00 or liquidate the position. The Maintenance Margin Requirement is the minimum amount of money which must be in the account (including open position profits and losses) to maintain an open position in the futures market. If the value of the account dips below this level, then the account holder must either send additional funds to his broker or liquidate the position. Usually, traders have 5 business days to get funds posted to the account, but in some cases, the brokerage firm may liquidate the futures positions in order to meet the Margin Call.
Reminder
Brokerages have the right to liquidate your position immediately, and many may require you to wire funds right away to avoid liquidation. Be aware that margin requirements are subject to change without notice.
Initial Margin is the minimum amount of money you must have in your account to open up a futures position. Maintenance Margin is the minimum amount of money you must have in your account to maintain the position. In the Corn example, the initial margin was $405.00 per contract, meaning that a trader must have at least $405.00 per contract in his margin account before a Corn futures position can be entered into. After the position is entered into a balance of $300.00 per contract, the Maintenance Margin must be maintained in order for the position to be left open. If the available funds in the account (funds deposited + open position profit or loss) are less than the Maintenance Margin Requirement, then more funds must be deposited or the futures positions will be liquidated or offset by taking an opposite position in the futures market. Reminder Long or buy positions are offset or closed by selling, while short or sell positions are offset or closed out by buying. The dual margining system (initial and maintenance) of the futures market ensures that all positions are adequately financed and the integrity of the futures market is secure. The exchanges set the minimum margin requirement based on the volatility and dollar value of the contract. Margin levels are subject to change both up and down at the discretion of the Exchange. Most brokerage firms charge the exchange minimum margin, but they are entitled to charge more. Be sure to check with your broker before entering into any futures transaction.
There are two basic positions one can have in the futures markets, a long or short position. A long position entails the purchase of futures contracts in anticipation of rising prices. A buyer enters into a long position when he/she purchases a futures contract. Long positions are profitable if the underlying futures contract increases in price during the holding period. Selling the same quantity and contract-month that one initially purchased offsets a long position. Long positions are typically used by consumers to hedge against rising prices and initiated by speculators in anticipation of higher prices. A short position entails the sale of futures contracts in anticipation of lower prices. A short position is entered into by initially selling a futures contract. In the futures market, unlike the stock market, it is just as easy to establish a short position as a long position. Short positions are profitable if the underlying futures contract decreases in price during the holding period. Buying the same quantity and contract month that you initially sold offsets your short positions. If the resulting purchase price is less than the original sale price, a profit is achieved. However, if the resulting purchase price is greater than the original sale price, a loss is incurred. Commodity producers who wish to avoid potentially lower prices (as a short position increases in value and prices decline) usually establish short positions.
Determining the profit or loss associated with a position is the same, whether you hold a long or short position. The profit or loss from a futures position is calculated as follows:
Profit or Loss = Sell Price - Buy Price x Contract Size x Number of Contracts
Example
Assume a speculator thinks that Corn prices will go down in the coming weeks. He sells 2 March Corn contracts at 235 cents per bushel ($2.35) initiating a short position.
Having studied the behavior of Corn using his Track ‘n Trade 5.0, our speculator was correct, and Corn prices fell from 235 to 220 over the next two weeks. Given the -15 cent drop in Corn prices, our speculator has a $1,500.00 open position profit and decides to "cash in" his winning by buying 2 March Corn futures at 220.
Profit or Loss = Sell Price - Buy Price x Contract Size x Number of Contracts
= 235 - 220 = +15 cents
= $0.15 x 5,000 bushel contract size = $750.00 per contract
= $750.00 per contract x 2 contracts = $1,500.00 (before commissions
and fees)
Now assume that another speculator buys 2 March Corn at 235 initiating a long position. After two weeks, prices drop by -.15 cents to 220, and he offsets the long position by selling 2 March Corn at 220. His loss from the transaction would be -$1,500.00 before commissions and fees.
Profit or Loss = Sell Price - Buy Price x Contract Size x Number of Contracts
= 220 - 235 = -15 cents
= -$0.15 x 5,000 bushel contract size = -$750.00 per contract
= -$750.00 per contract x 2 contracts = -$1,500.00 (before commissions
and fees)
As you can see, whether you are long or short, the basic idea of speculating in the futures market is to "buy low" and "sell high." In the futures market this can be done in any order. You can initiate a long position by buying the futures first and offsetting by selling at a later time. If the sale price (exit price) is higher than the purchase price (entry price), you profit. Or, you can initiate a short position by selling the futures first and then offsetting the contract(s) at a later time by buying them. A profit will always occur if the sale price is higher than the purchase price.
The profit or loss amount is determined by the contract you are trading. Each futures contract is quoted in a slightly different manner, and as such your profit or loss calculation for most markets is slightly different. The following highlights the major markets and how they are quoted. Of course, Gecko Software’s Track ‘n Trade 5.0 will convert price moves to profit or loss for you, but these examples will help you understand how it is done.
Grains: Corn, Wheat, Oats, and Soybeans are quoted in cents per bushel, with a contract size of 5,000 bushels. A Corn price of 235 is really $2.35 per bushel. Each of these grains moves in 1/4 cent increments, which equates to $12.50 before commissions and fees. The profit or loss of a one cent move is $50.00 before commissions and fees.
Meats: The contracts are quoted in cents per pound. If Live Cattle is trading at 74.00, the price is actually 0.74 cents per pound. Meat prices move in 0.025 cents per pound increments, but usually the last 0.005 cent per pound is dropped, so a price quote of 74.02 is really 74.025, while a price quote of 74.17 is actually 74.175. Live Cattle, Lean Hogs, and Pork Bellies contracts call for delivery of 40,000 pounds, making a 0.025 cent per pound worth $10.00 before commissions and fees. The profit or loss of a one cent move is $400.00 before commissions and fees. Feeder Cattle prices are quoted the same way, except they call for 50,000 pounds, making a 0.025 cent move is worth $12.50 and a one cent move in Feeder Cattle worth $500.00 before commissions and fees.
"Softs" or Exotics: Coffee, Sugar, and Orange Juice are all quoted in cents per pound, but each has a different contract size. A Coffee price of 50.40 is 50.40 cents per pound, an Orange Juice price of 89.95 is 89.95 cents per pound, and a Sugar price of 762 is really 7.62 cents per pound (prices in Sugar are quoted in cents per hundred weight). Cocoa prices are quoted in dollars per metric ton, so a price of 1301 is really $1301 per metric ton.
The contract size for Coffee is 37,500 pounds, making a 1 cent move worth $375.00 before commissions and fees. Orange Juice futures call for delivery of 15,000 pounds, making a 1 cent move worth $150.00 before commissions and fees. Sugar is traded in 112,000 pound increments, making a 1 cent move in Sugar equal to $1,120.00 before commissions and fees. Cocoa contracts call for 10 metric tons at delivery, making a $1 move in Cocoa worth $10.00 before commissions and fees.
Metals: Gold and Platinum prices are quoted in dollars per troy ounce. Most quote vendors display their prices in this format as well, so prices are easy to read. A Gold price of 285.10 is $285.10 per troy ounce, while a Platinum price of 475.5 is $475.50 per troy ounce. However, each contract has a different contract size. Each Gold futures contract represents 100 troy ounces, so a $1.00 per troy ounce move equates to $100.00 before commissions and fees. Platinum futures represent only 50 troy ounces, as Platinum is much more rare than Gold. Each $1.00 per toy ounce move in Platinum is equal to $50.00 before commissions and fees.
Silver and Copper Futures are quoted in cents: cents per troy ounce in Silver, and cents per pound in Copper. A Silver price of 452.5 is actually $4.525 per ounce, while a Copper price of 70.20 is really $0.7020 per pound. Each Silver contract represents 5,000 ounces, making a 1.0 cent move equal $50.00 before commissions and fees. Copper contracts control 25,000 pounds of copper, making a 1.00 cent move equal $250.00 before commissions and fees.
Petroleum: Crude oil is quoted in dollars per barrel (bbl). A price of 20.50 is $20.50 per barrel. Each contract represents 1,000 barrels of oil, making a $1.00 barrel move equal to a $1,000.00 profit or loss before commissions and fees.
Heating Oil and Unleaded Gasoline are the same as at the pump (minus taxes and service station mark-ups) in cents per gallon. A price of 52.46 is $0.5246 per gallon. Both contracts call for delivery of 42,000 gallons; therefore, a 1 cent per gallon equates to $420.00 before commissions and fees.
Currencies: Currencies represent an exchange rate, or how many US Dollars it takes to buy one Swiss Franc, Japanese Yen, Euro, or Mexican Peso. Prices are quoted in many different fashions, but the basic convention is that a 0.01 move in the Swiss Franc or Yen equals $12.50 before commissions and fees because of the contract size. The Canadian Dollar, US Dollar Index, and Euro have a different contract size, and a 0.01 move equates to $10.00 before commissions and fees.
Financials: The same basic principles apply to the financial markets, which are generally quoted in terms of points. Prices are usually read as is, though some, like the treasury securities (US, TY, FV, TU), are traded in different combinations of 1/32nd or 1/64th. Each of these markets has the dollars per point already calculated into Gecko Software’s Track ‘n Trade 5.0 application, and a list of the different contract sizes and pricing terms are available from the various exchanges they trade on, as they do not follow a single convention.
Before entering into either a long or short position, one must post a performance bond or have the initial margin requirement. Because it is only necessary to post a fraction of the underlying value of the worth of the underlying contract, futures are a highly leveraged trading vehicle.
Initial margin requirements vary from market to market, but are generally only 3% to 18% of the value of the underlying contract value.
Example
If March Corn is trading at 211 per bushel ($2.11/bushel), the current initial margin requirement is $405 per contract. Each Corn futures contract represents 5,000 bushels of Corn, so the underlying value of a contract of Corn at 211 is $10,550. In other words, for $405 you can control $10,550 worth of Corn. By putting up just 3.9% of the value of the contract, you can control 5,000 bushels of Corn. (Margin requirements are subject to change without notice.)
In this example, a 1 cent move in the price of Corn ($50.00 before commissions and fees) represents a 12.3% return on the Initial Margin Requirement. This is the power of leverage. A small move in the price of the futures contract can mean a large move in your account.
Because of this kind of leverage, a 3.9% move in the price of Corn could give you a 100% return, double your money, or a loss of it all, if properly or improperly positioned. The power of trading on margin is that a small move in the price of the underlying equates to a large return (either positive or negative) on the money posted.
Just as physical leverage increases the amount of force used, like a pulley lifting very heavy objects, financial leverage increases the amount of money, which can be made or lost in the markets. As they say in Chicago, "The futures markets have made millionaires of more young men than Rock and Roll."
However, we want to point out that leverage is a two-edged sword. Over leveraging your trading is a sure fire way to lose your money. Because of the leverage of a roulette wheel, each bet on a specific number pays off at 35 to 1. If you bet "6" and the ball bounces and lands on "6", every $1 you bet is paid back to you with $35 dollars.
Let’s say you start off with $1 and bet "6" and win. You now have $35 and bet it all on "6", which comes up again. You take your $1,225 winnings and let them ride on "6" again and win, reaping $42,875. Let it ride again, making a phenomenal $1,500,625. You let it ride one more time, and up pops "00." You lose everything.
Though roulette is strictly a game of chance, the above results are possible with futures because of the leverage involved. If you buy 1 Corn futures contract at 210 and the price goes up to 219, you have enough open position profit to post margin for a second contract. Prices then rise another .04 cents, and you buy a third contract. With Corn prices having risen .13 cents, you were able to buy 3 contracts with an initial investment of only $405.00. However, all it takes is a .05 cent decline in the price of Corn and all your profits are gone. If you were lucky enough to see another 5 cent rise, you would yield a $1,450.00 profit or a 358% return on the initial margin.
It is possible to make highly leveraged, and possibly highly profitable, transactions in the futures markets by trading with relatively little financial cushion and pyramiding contracts. However, it has been our experience that those who practice this type of trading generally do not end up making money, but losing it.
Most people are attracted to trading futures because of the leverage involved, and it is the leverage that seems to ruin most traders. Though futures trading should only be done with genuine risk capital, this does not mean you should take undo risk. As a general rule of thumb, traders should learn to diversify their risk, only placing a small percentage of their capital at risk at any given time.
Though this style of trade will reduce the largest "bang for your buck" in the short run, it may prevent you from losing everything. In order to learn this game, you need to be able to stick around to learn all the rules (both written and unwritten), and the only way to stick around is through prudent money management.
The size of your account and the amount of risk you are personally able to bear is a completely personal matter. Some very successful traders—like Richard Dennis, who is rumored to have parlayed $1,000.00 into several millions in the futures markets—have made fortunes starting with relatively small sums of money. Most professional fund managers risk as little as 1% of their account equity on any given trade.
Unfortunately, both of these methods are probably out of the question for most people starting out in the futures market. The odds of turning $1,000.00 into several million in a couple of years is akin to hitting "6" on the roulette wheel 5 times in a row, but risking 1% of a $1,000 means only risking $10.00 per trade, which is just not practical. By postponing your entrance into the futures market until you have, for example, a $5,000.00 minimum of genuine risk capital (not the kids college fund, the rent, or your next mortgage payment), you could achieve a level of diversity and risk, theoretically then risking 10% of your account ($500.00 before commissions and fees) on any one trade realistically. This would greatly reduce your risk of ruin and increase your ability to trade longer and hopefully become more proficient in the long run.
Futures orders may be placed by selecting the Buy/Sell Place Order button found in the Accounting Tools toolbar.
Market Order (MKT): A market order does not specify a price; it is executed at the best possible price available. Track 'n Trade fills these orders at the opening price of the next day's trading.
Stop Order (STP): Stop orders to buy are placed above the market price; stop orders to sell are placed below the market price. A stop order becomes a filled market order when the specified price is reached. Track 'n Trade fills these orders when that price is within the trading range for the given day.
Limit Order (LMT): Limit orders to buy are placed below the market price; limit orders to sell are placed above the market price. A limit order becomes a filled market order when the specified price is passed through. Track 'n Trade fills limit orders when the market trades BETTER than the limit price for the given day.
Market If Touched (MIT): Similar to limit orders, MIT orders to buy are placed below the market price; MIT orders to sell are placed above the current price. MIT orders fill once the MIT price is touched or passed through. Track 'n Trade fills MIT orders when that price is within the trading range for the given day.
Market On Close (MOC): Market On Close orders fill during the final minutes of trading at whatever price is available. Track 'n Trade fills these orders at the closing price of the next day's trading.
Market On Open (MOO): Market On Open orders fill during the opening range of trading at the best possible price obtainable within the opening range. Track 'n Trade fills these orders at the opening price of the next day's trading.
Good 'Til Cancelled (GTC): An order that is Good 'Til Cancelled (GTC) is pending until it is either canceled by the client or filled. Track 'n Trade evaluates whether to fill a GTC order every day from the day the order was placed. If a non-GTC order is canceled, simply delete it from Track 'n Trade if you wish.
Would you like to learn about a commodity price chart that is possibly more effective than the type you are currently using? If you are brand new to the art of chart reading, don't worry. This stuff is really quite simple to learn.
Technical analysis is simply the study of prices as reflected on price charts. Technical analysis assumes that current prices should represent all known information about the markets. Prices not only reflect essential facts, they also represent human emotion and the pervasive mass psychology and mood of the moment. Prices are, in the end, a function of supply and demand. However, on a moment to moment basis, human emotions such as fear, greed, panic, hysteria, elation, etc., also dramatically affect prices. Markets may move not based on facts, but upon people's expectations. A market "technician" attempts to disregard the emotional component of trading by making his decisions based upon chart formations. He assumes that prices reflect both facts and emotion.
Standard bar charts are commonly used to convey price activity into an easily readable chart. Usually, four elements make up a bar chart, the Open, High, Low, and Close for the trading session/time period. A price bar can represent any time frame the user wishes, from 1 minute to 1 month. The total vertical length/height of the bar represents the entire trading range for the period. The top of the bar represents the highest price of the period, and the bottom of the bar represents the lowest price of the period. The Open is represented by a small dash to the left of the bar, and the Close for the session is a small dash to the right of the bar.
You may be asking yourself, "If I can already use bar charts to view prices, then why do I need another type of chart?"
The answer to this question may not seem obvious, but after going through the following candlestick chart explanations and examples, you will surely see value in the different perspective candlesticks bring to the table. In my opinion, they are much more visually appealing and convey the price information in a quicker, easier manner.
Candlestick charts are on record as being the oldest type of charts used for price prediction. They date back to the 1700's when they were used for predicting rice prices. In fact, during this era in Japan, Munehisa Homma become a legendary rice trader and gained a huge fortune using candlestick analysis. He is said to have executed over 100 consecutive winning trades!
The candlesticks themselves and the formations they shape were given colorful names by the Japanese traders. Due in part to the military environment of the Japanese feudal system during this era, candlestick formations developed names such as "counter-attack lines" and the "advancing three soldiers." Just as skill, strategy, and psychology are important in battle, they are also important elements in the midst of a trading battle.
Candlestick charts are much more visually appealing than a standard two-dimensional bar chart. As in a standard bar chart, there are four elements necessary to construct a candlestick price bar: the open, high, low, and closing price for a given time period. Here are examples of candlesticks with definitions for each candlestick component:
The body of the candlestick is called the real body, and represents the range between the open and closing prices.
A black or filled-in body represents that the close during that time period was lower than the open, (normally considered bearish) and when the body is open or white, that means the close was higher than the open (normally considered bullish).
The thin vertical line above and/or below the real body is called the upper/lower shadow, representing the high/low price extremes for the period.
Below is an example of the same price data conveyed in a standard bar chart and a candlestick chart. Notice how the candlestick chart appears 3 dimensional, as price data almost jumps out at you.
The long, dark, filled-in real bodies represent a weak (bearish) close, while a long open, light-colored real body represents a strong (bullish) close. It is important to note that Japanese candlestick analysts traditionally view the open and closing prices as the most critical of the day. At a glance, notice how much easier it is with candlesticks to determine if the closing price was higher or lower than the opening price.
The following is a list of some individual candlestick terms. It is important to realize that many formations occur within the context of prior candlesticks. What follows is merely a definition of terms, not formations.
The Black Candlestick -- the close is lower than the open.
The White Candlestick -- the close is higher than the open.
The Shaven Head -- a candlestick with no upper shadow.
The Shaven Bottom -- a candlestick with no lower shadow.
Spinning Tops -- candlesticks with small real bodies. When appearing within a sideways choppy market, they represent an equilibrium between the bulls and the bears. They can be either white or black.
Doji Lines -- candlesticks with no real body, but instead have a horizontal line. This represents when the Open and Close are the same or very close. The length of the shadow can vary.
Just as many traders look to bar charts for double tops and bottoms, Head & Shoulders, and technical indicators for reversal signals, candlestick formations can also be looked upon for the same purpose. A reversal does not always mean that the current uptrend/downtrend will reverse direction, but merely that the current direction may end. The market may then decide to drift sideways. Candlestick reversal patterns must be viewed, within the context of prior activity, to be effective. In fact, identical candlesticks may have different meanings depending on where they occur within the context of prior trends and formations.
Hammer -- a candlestick with a long lower shadow and small real body. The shadow should be at least twice the length of the real body, and there should be no or very little upper shadow. The body may be either black or white, but the key is that this candlestick must occur within the context of a downtrend to be considered a hammer. The market may be "hammering" out a bottom.
Hanging Man -- identical in appearance to the hammer, but appears within the context of an uptrend.
Engulfing Patterns -- Bullish -- when a white, real body totally covers (engulfs) the prior day's real body. The market should be in a definable trend, not chopping around sideways. The shadows of the prior candlestick do not need to be engulfed.
Bearish -- when a black, real body totally covers, "engulfs" the prior day's real body. The market should be in a definable trend, not chopping around sideways. The shadows of the prior candlestick do not need to be engulfed.
Dark-Cloud Cover (bearish) -- a top reversal formation where the first day of the pattern consists of a strong white, real body. The second day's price opens above the top of the upper shadow of the prior candlestick, but the close is at or near the low of the day, and well into the prior white, real body.
Piercing Pattern (bullish) -- opposite of the dark-cloud cover. Occurs within a downtrend. The first candlestick having a black real body, and the second has a long, white real body. The white day opens sharply lower, under the low of the prior black day. Then, prices close above the 50% point of the prior day's black real body.
Stars -- These candlestick formations consist of a small real body that gaps away from the real body preceding it. The real body of the star should not overlap the prior real body. The color of the star is not too important, and they can occur at either tops or bottoms. Stars are the equivalent of gaps on standard bar charts.
Morning Star -- a bullish bottom reversal pattern. The formation is comprised of 3 candlesticks. The first candlestick is a tall black real body followed by the second, a small real body, which gaps (opens) lower (a star pattern). The third candlestick is a white real body that moves well into the first period's black real body. This is similar to an island pattern on standard bar charts.
Evening Star -- a bearish top reversal pattern and counterpart to the Morning Star. Three candlesticks compose the evening star, the first being long and white. The second forms a star, followed by the third, which has a black real body that moves sharply into the first white candlestick.
Doji Stars -- When a doji gaps above a real body in an uptrend, or gaps under a real body in a falling market, that particular doji is called a doji star. Two popular doji stars are the evening star and the morning star.
Evening Doji Star -- a doji star in an uptrend followed by a long, black real body that closed well into the prior white real body. If the candlestick after the doji star is white and gapped higher, the bearishness of the doji is invalidated.
Morning Doji Star -- a doji star in a downtrend followed by a long, white real body that closes well into the prior black real body. If the candlestick after the doji star is black and gapped lower, the bullishness of the doji is invalidated.
Shooting Star -- a small real body near the lower end of the trading range, with a long upper shadow. The color of the body is not critical. Not usually considered a major reversal sign, only a warning.
It is important to realize that this introduction is just that, an introduction to candlestick analysis. After having read this, you will have merely scratched the surface of the many patterns and variables that can go into candlestick analysis. No attempt was made to provide a thorough analysis of each and every pattern. In fact, many formations were left out as they cross the border into a more complicated analysis. For a more complete overview of candlestick analysis, it is highly recommended that you read the book that is referred to below.
A large portion of the material in this introduction is taken from an excellent book called Japanese Candlestick Charting Techniques: A Contemporary Guide to the Ancient Investment Techniques of the Far East. (You can find this book in The PitMaster's Bookstore www.thepitmaster.com [1].) In some cases, sentences were taken almost verbatim, as there was no better way to say what Mr. Steve Nison, the author, already said. In his book, Mr. Nison completely explains candlesticks and their formations, but more importantly explains how to combine candlestick analysis with traditional technical analysis. It is highly recommended that you consider purchasing this book.
As traders, we need many trading tools in our arsenal, and a basic knowledge of candlesticks provides a trader much needed ammunition. Also remember that no matter what the trading tool, no matter how advanced or ancient, it is only effective when put into practice properly. This is your job as the trader.
A Message from the Chairman and Founder
Before starting a business it is important to have a business plan and have adequate capital. Most new businesses start off with a dream, and the proprietor’s willingness to work hard. Despite hard work, they can fail because of unforeseen difficulties, poor preparation, or lack of capital. Remember this when starting your trading business: try to have adequate capital and plan for the unforeseen by developing and testing a trading plan.
Before trading, it is imperative that you develop a trading plan.
Your trading plan should be capitalized with money you can afford to lose. Generally trading funds are categorized as genuine risk capital if it is money that you can afford to lose. Again, this is not your child’s college education fund, the mortgage money, or grocery money. Proper planning and adequate capitalization are the cornerstones of any new venture.
The first step in building a house is drawing up plans for the completed house. The workmen who erect the house consult the blueprints when placing walls, sinks, appliances, and electrical outlets. The transition from bare ground to a finished home is laid out in the blueprints, or the plan for the completed structure. Trades should be planned with as much detail. Every situation should be planned for, so decisions are not made in the heat of the moment when money is on the line.
The goal of your trading plan is to allow you to make decisions before things happen, giving you a blueprint for trading before entering the market. A basic trading plan should include the following features as a minimum:
Once you have developed your trading plan, put it to the test by "Paper Trading." Paper trading is fictitious trading, or simulated trading, best done using Gecko Software’s Track ‘n Trade 5.0 market simulator program, in which you simulate buying and selling futures contracts, without risking real money. The whole purpose of paper trading is to be as realistic as possible when doing it. It does no good to practice trading with a million dollars, if you are going to start with $10,000. Don’t practice your trading in the S&P if you are intending to actually trade Corn. Keep your practice as realistic as possible.
The one major downfall to paper trading is that it does not involve real money. It is very easy to live through a fictitious losing streak but quite different to live through it when it is your money on the line. Because paper trading does not involve real money, your emotions are kept at bay, but tend to creep up when real money is involved.
Gecko Software’s Track ‘n Trade 5.0 comes with over 25 years of historical data on over 50 different markets, allowing you to learn the markets and develop a trading plan. Six different plug-ins are available for Track ‘n Trade 5.0 to help you maximize your trading strategies. The plug-ins are listed below:
Accounting Plug-in: Enables Track ‘n Trade 5.0 users to simulate placing life-like orders, applying deposits and making withdrawals. Also, it keeps track of commissions paid to your simulated (or live) broker, tracks orders placed, profits & losses, and even simulates margin calls.
Options Plug-in: The order tools included with this plug-in automatically snap to the different strike prices to show you the actual dollar value of the option on that particular day. Track ‘n Trade 5.0 users who have this plug-in keep track of options profit and losses concurrent with your futures orders, allowing them to practice mixing futures and options strategies simultaneously.
Seasonal Plug-in: Comprised of three indicators for the seasonal market, this plug-in assists the Track ‘n Trade 5.0 user to calculate seasonal trends and market probability, and gives historical averages. All this information is based on what has happened to a particular seasonal contract in the past.
Spreads Plug-in: Place orders directly on the spread chart and let Track ‘n Trade 5.0 automatically simulate placing both orders in the opposing contracts, and calculate your daily profits and losses in the Accounting and Simulation Plug-in module.
Commitment of Traders Plug-in: Gives you the overall picture of what is happening behind the scenes of each market. It actually tells you who’s buying and who’s selling, from large professional trade, commercial traders, and small speculators. This information is a great indicator for which way the market will turn.
Bulls ‘n Bears Trading System: The first trading system designed for Track ‘n Trade 5.0 users. This trading system includes easily usable tools to see if the market is bullish or bearish. Bulls ‘n Bears allows you to change the sensitivity of the system according to your trading style, whether you are an aggressive trader or a more traditional trader.
Autopilot Plug-in: Autopilot is more than just a simple trading system, it was developed with the individual trader in mind, and with the mindset that trading methods are more powerful and more profitable that trading systems alone. We here at Gecko Software have created the Autopilot system trading platform in such a fashion that we integrate the advantages of system trading, with the advantages of method trading, allowing the Track ‘n Trade Autopilot to automatically execute your own personal trading methodology, not just a simple trading system.
Candlestick Auto-Recognition Plug-in: Track ‘n Trade’s unique method of automatically identifying, cataloging, and signaling buy and sell signals derived from various candlestick formations is unique in the fact that Track ‘n Trade gives the trader the ability to filter out, or ‘decide’ what a true candlestick must match, prior to receiving a signal.
So, before ever attempting to trade in the futures market, develop a strategic plan. Your trading plan should be realistic and well tested over past history. Once it has been developed, take six months and paper trade; "simulate" trading in "real time," using Track ‘n Trade 5.0. If the plan still holds up, then remember the mantra of futures traders: "Plan your Trade, and Trade Your Plan."
Good Luck,
Lan H. Turner, Chairman and Founder
Gecko Software, Inc.
Links
[1] http://www.thepitmaster.com