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A question often asked is whether technical analysis as applied to futures is the same as the stock market. The answer is both yes and no. The basic principles are the same, but there are some significant differences. The principles of technical analysis were first applied to stock market forecasting and only later adapted to futures. Most of the basic tools—bar charts, point and figure charts, price patterns, volume, trendlines, moving averages, and oscillators, for example—are used in both areas. Anyone who has learned these concepts in either stocks or futures wouldn't have too much trouble making the adjustment to the other side. However, there are some general areas of difference having more to do with the different nature of stocks and futures than with the actual tools themselves.
The pricing structure in futures is much more complicated than in stocks. Each commodity is quoted in different units and increments. Grain markets, for example, are quoted in cents per bushel, livestock markets in cents per pound, gold and silver in dollars per ounce, and interest rates in basis points. The trader must learn the contract details of each market: which exchange it is traded on, how each contract is quoted, what the minimum and maximum price increments are, and what these price increments are worth.
Unlike stocks, futures contracts have expiration dates. A March 1999 Treasury Bond contract, for example, expires in March of 1999. The typical futures contract trades for about a year and a half before expiration. Therefore, at any one time, at least a half dozen different contract months are trading in the same commodity at the same time. The trader must know which contracts to trade and which ones to avoid. (This is explained later in this book.) This limited life feature causes some problems for longer range price forecasting. It necessitates the continuing need for obtaining new charts once old contracts stop trading. The chart of an expired contract isn't of much use. New charts must be obtained for the newer contracts along with their own technical indicators. This constant rotation makes the maintenance of an ongoing chart library a good deal more difficult. For computer users, it also entails greater time and expense by making it necessary to be constantly obtaining new historical data as old contracts expire.
This is probably the most important difference between stocks and futures. All futures are traded on margin, which is usually less than 10% of the value of the contract. The result of these low margin requirements is tremendous leverage. Relatively small price moves in either direction tend to become magnified in their impact on overall trading results. For this reason, it is possible to make or lose large sums of money very quickly in futures. Because a trader puts up only 10% of the value of the contract as margin, then a 10% move in either direction will either double the trader's money or wipe it out. By magnifying the impact of even minor market moves, the high leverage factor sometimes makes the futures markets seem more volatile than they actually are. When someone says, for example, that he or she was“wiped out”in the futures market, remember that he or she only committed 10% in the first place.
From the standpoint of technical analysis, the high leverage factor makes timing in the futures markets much more critical than it is in stocks. The correct timing of entry and exit points is crucial in futures trading and much more difficult and frustrating than market analysis. Largely for this reason, technical trading skills become indispensable to a successful futures trading program.
Because of the high leverage factor and the need for close monitoring of market positions, the time horizon of the commodity trader is much shorter of necessity. Stock market technicians tend to look more at the longer range picture and talk in time frames that are beyond the concern of the average commodity trader. Stock technicians may talk about where the market will be in three or six months. Futures traders want to know where prices will be next week, tomorrow, or maybe even later this afternoon. This has necessitated the refinement of very short term timing tools. One example is the moving average. The most commonly watched averages in stocks are 50 and 200 days. In commodities, most moving averages are under 40 days. A popular moving average combination in futures, for example, is 4, 9, and 18 days.
Timing is everything in futures trading. Determining the correct direction of the market only solves a portion of the trading problem. If the timing of the entry point is off by a day, or sometimes even minutes, it can mean the difference between a winner or a loser. It's bad enough to be on the wrong side of the market and lose money. Being on the right side of the market and still losing money is one of the most frustrating and unnerving aspects of futures trading. It goes without saying that timing is almost purely technical in nature, because the fundamentals rarely change on a day-to-day basis.