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Position Limits
Although the average trader is unlikely
to ever approach them, exchanges and the CFTC establish limits on
the maximum speculative position that any one person can have at one
time in any one futures contract. The purpose is to prevent one
buyer or seller from being able to exert undue influence on the
price in either the establishment or liquidation of positions.
Position limits are stated in number of contracts or total units of
the commodity.
The easiest way to obtain the types of
information just discussed is to ask your broker or other advisor to
provide you with a copy of the contract specifications for the
specific futures contracts you are thinking about trading. Or you
can obtain the information from the exchange where the contract is
traded.
Understanding the risks of futures
trading
Anyone buying or selling futures
contracts should clearly understand that the risks of any given
transaction might result in a futures trading loss. The loss may
exceed not only the amount of the initial margin but also the entire
amount deposited in the account or more. Moreover, while there are a
number of steps that can be taken in an effort to limit the size of
possible losses, there can be no guarantees that these steps will
prove effective. Well-informed futures traders should, nonetheless,
be familiar with available risk management possibilities
Choosing a futures contract
Just as different stocks or different
bonds may involve different degrees of probable risk and reward at a
particular time, so may different futures contracts. The market for
one commodity may, at present, be highly volatile, perhaps because
of supply-demand uncertainties that, depending on future
developments could suddenly propel prices sharply higher or sharply
lower. The market for some other commodity may currently be less
volatile, with greater likelihood that prices will fluctuate in a
narrower range. You should be able to evaluate and choose the
futures contracts that appear, based on present information, most
likely to meet your objectives and willingness to accept risk.
Keep in mind, however, that neither
past nor even present price behavior provides assurance of what will
occur in the future. Prices that have been relatively stable may
become highly volatile (which is why many individuals and firms
choose to hedge against unforeseeable price changes)
Liquidity
There can be no ironclad assurance
that, at all times, a liquid market will exist for offsetting a
futures contract that you have previously bought or sold. This could
be the case if, for example, a futures price has increased or
decreased by the maximum allowable daily limit and there is no one
presently willing to buy the futures contract you want to sell or
sell the futures contract you want to buy.
Even on a day-to-day basis, some
contracts and some delivery months tend to be more actively traded
and liquid than others. Two useful indicators of liquidity are the
volume of trading and the open interest (the number of open futures
positions still remaining to be liquidated by an offsetting trade or
satisfied by delivery). These figures are usually reported in
newspapers that carry futures quotations. The information is also
available from your broker or advisor and from the exchange where
the contract is traded
Timing
In futures trading, being right about
the direction of prices isn't enough. It is also necessary to
anticipate the timing of price changes. The reason, of course, is
that an adverse price change may, in the short run, result in a
greater loss than you are willing to accept in the hope that you
will eventually be correct.
Example: In January, you deposit
initial margin of $1,500 to buy a May wheat futures contract at
$3.30 - anticipating that, by spring, the price will climb to $3.50
or higher. Soon after you buy the contract, the price drops to
$3.15, a loss of $750. To avoid the risk of a further loss, you have
your broker liquidate the position. The possibility that the price
may now recover and even climb to $3.50 or above is of no
consolation.
The lesson to be learned is that
deciding when to buy or sell a futures contract can be as important
as deciding what futures contract to buy or sell. In fact, it can be
argued that timing is the key to successful futures trading
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