That’s an understandable reaction. Futures are volatile, and they’re fraught with hypothetically unlimited risk. Futures have been known to wipe out multi-millionaire professional traders… so, it’s no surprise amateur investors prefer to keep their distance from them. But they’re also one of the best tools you have to predict what’s going to happen with stock prices.

Today, I want to show you how you can easily use futures to see what’s about to happen in stocks, as well as what’s on the horizon for the economy…

First off all, let’s start off with a definition: A futures contract is an agreement between two parties to exchange a specified asset at a pre-determined date for a pre-determined price. Futures have been around since the days of Aristotle, providing a way for farmers to lock in the prices of their crops ahead of time, erasing some of the uncertainty of their harvest.

If a farmer wanted to lock in a good price on his wheat crop, for instance, he could pre-sell all of that wheat to a baker with a futures contract, and avoid unforeseen price swings in the wheat market. The baker benefits too, because he’s able to lock in his wheat costs for a loaf of bread this year.

Futures are still used by major growers, but they’re not limited to soft commodities (stuff you can grow) anymore. Today, there are futures available for everything from stock indexes to interest rates to orange juice…

But I’m not suggesting that you start trading orange juice futures like Eddie Murphy and Dan Aykroyd in Trading Places. Instead, I want to show you how you can use these financial instruments as a prediction tool.

Because futures are available for financial indexes, such as the S&P 500 or the NASDAQ Composite, we can get some early insights about where the market is headed. You see, futures trade outside of normal market hours — while you have to wait until 9:30 Eastern for the NYSE to open for regular trading, futures on major stock indexes are trading almost around the clock. That means that futures prices can give you a preview of the day’s open hours in advance…

This morning, the S&P 500 opened down approximately 0.5%— but investors who were looking at futures this morning got a preview of today’s price action several hours in advance. In the real world, that sort of advance notice could be enough to tell you whether today’s going to be a good day to take on a new position, or whether a stop loss level is going to get knocked out. Having the extra time to prepare for a trade can be crucial.

To be sure, futures aren’t the only option for investors looking to get a preview of the day’s price action — pre-market trading can offer a similar glimpse at individual stocks’ likely behavior. Even so, because futures tend to be more liquid than most pre-market names, they’re a better indicator of what to expect.

Futures aren’t just good short-term predictive tools for stocks — they’re also a valuable way to preview economic data such as inflation.

Remember, futures got their start as a way to price commodities. Today, when people talk about the price of oil, gold, cattle, or timber, they’re typically talking about futures prices. Because commodities are directly related to inflation (increasing commodity/raw material prices means that you’re paying more for the goods you buy), they can be a good indicator of what’s going on with inflation…

So, if futures contracts for oil, timber, and silver are rallying, chances are that those increasing prices are going to get passed down to consumers and increase the rate of inflation. For income-focused investors, that’s an important observation; after all, high inflation eats away at the real yields you’re getting on stocks and bonds. (Of course, the opposite is true too.)

From stock prices to inflation, futures are the tool that can give you extra insights into the market. So, how do you actually use them?

While you can’t yet get futures data on popular sites like Google Finance, futures prices aren’t hard to find. If your broker offers futures trading, then they’re the best place to turn to get real time futures pricing data. Otherwise, a number of websites offer delayed futures prices for a number of different instruments (Bloomberg’s futures page is one example. StockCharts.com also offers free end-of-day charting for a number of different futures products here.)

Your preview of the market’s action may be as simple as opening your trading software, or logging onto your favorite financial site. It’s an effortless way to get advance notice if a major trading day is shaping up.

Whenever you’re planning on making a trade, I’d recommend sitting down early that morning and checking out what’s going on with E-mini S&P 500 Index Futures (if you can’t spot them right away, the ticker is usually ES or /ES depending on your data provider). If futures are pointing to an unusual open, you’ll have that much more time to plan your next move.

Even if trading futures isn’t your cup of tea, this tool can still provide a substantial amount of information to any investor. Whether you’re looking for a preview on inflation or just a jump on the morning’s open, you should add futures charts to your trading toolbox.

Cheers,

Jonas Elmerraji
for The Penny Sleuth

Preview Stock Prices Using Futures was originally featured in the Penny Sleuth.

Most average investors think the tool I’ll show you is too complicated. Or too risky.

But studies performed by Goldman Sachs and the Chicago Mercantile Exchange concluded that portfolios that included this tool yield higher returns than those relying on stocks and bonds alone.

What is this “tool”? And how can you add it to your portfolio? Let me explain…

The tool I’m talking about is something called “Futures contracts” – also known simply as “futures.”

A future contract is an investment instrument that allows you to hedge or speculate the future price of an asset.  The beauty of futures is that you aren’t held to just speculate on the price of stock alone – futures allow you to speculate on whether you think a specific currency or commodity is going to go up or down.

Similar to options, futures contracts are similar to a placing a bet. Instead of betting on your favorite sports teams, you are betting on the prices of a particular asset (a commodity, currency, stock, etc.).  Purchasing a futures contract guarantees the buyer the obligation to purchase an asset at a predetermined price at a set time.

Also similar to options, with futures you post a small fee to control a large amount of commodity assets. This leverage allows you to make big gains on small price movements.

Most discount brokerages require only between 5 and 10% of the cost to be paid at the time you purchase the contract. This means you have the chance to get into these contracts at a fairly cheap price. But, it is important to note, that depending on the volatility of the market, your broker can require you to add more into this account.

Here’s an example of how it works…

Lets say milk costs $2 per gallon right now. And you think – for whatever reason – it’ll go to $3 per gallon by September.

A futures contract lets you bet on exactly that. You don’t have to try to play a dairy stock or a major food producer. You can bet on the price of the commodity directly.

There is, however, one BIG difference between futures and options…

Unlike options, where you have the right not the obligation to purchase the underlying asset at a specific price, futures contracts obligate you to purchase the asset. (Keep in mind some futures are settled in cash.)

That means unless you sell your milk futures contract, you may just have a massive amount of milk show up on your doorstep in September.

Of course, most traders are not looking to purchase gallons of milk, barrels of oil or bushels of grain – they just want the opportunity to profit from the price movements.

To relieve yourself of this obligation you will want to close the future contract before the settlement date, or expiration date.

Again, as an investor, futures permit you to take away large gains on small price movements.

Better yet, your profits will be put to your account daily. Unlike the stock market, the futures market is settled on a daily basis. Gains and loses for the day are debited or credited to your trading account each day.

So, where do you start?

Because the futures market allows to invest in more then just stock prices, it is important to become familiar with the area you want purchase your contracts in. Doing you research on the fundamentals of the currency market, commodity market or whichever market you want to invest in is key.

You will also want to make sure your broker allows 24 hour trading for futures. Because most of the futures market is open 24 hours a day, 7 days a week – 24-hour access could make or break your trading capabilities.

If you have never traded futures before, it is probably not wise to dive in right away with your hard earned money. This is only a brief description of what can be a complex market.

The National Futures Association (NFA) has a number of free online learning programs I recommend you check out, just click here.

I also would recommend setting up a trial account. Track you futures trades and see how you do.  Many discount brokers offer future trading simulators to their account holders.  You can also check out Trading Simulator, a free trading simulator, by clicking here.

Who knows, you could find that you have an aptitude analyzing the everyday trends in the futures markets.  And if you do, you could be rewarded handsomely by adding profits to your investment portfolio.

Sincerely,

Jessica Comitto
Associate Editor, Penny Sleuth

Focusing on “Future” Profits was originally featured in the Penny Sleuth.

On Wednesday, I told you how out of control breakeven prices for oil producers were a sign that oil prices were due to push back into the triple digits. I also told you that one ETF was the best way to make a play for black gold right now.

That’s because only oil ETFs let you take advantage of oil’s moves just as easily as you’d invest in a regular stock…

There are a large number of oil and oil-related ETFs trading on the market right now –including funds that invest in oil futures and those that hold shares of oilfield service companies. But investing in oil through companies that service oil producers is a risky play; as the Exxons of the world continue to see their margins evaporate, they’ll be unlikely to enter into many major development obligations that these companies live on.

Right now, there are only three oil futures ETFs trading on the market: the U.S. Oil Fund ETF (NYSE: USO), the PowerShares DB Oil Fund ETF (NYSE: DBO) and the iPath S&P GSCI Crude Oil Total Return Index ETN (NYSE: OIL).

But of the three, only one stands out as a good investment right now…

For starters, the iPath fund isn’t actually an ETF at all – it’s an exchange-traded note (ETN) — a debt security that’s linked to changes in the crude oil commodity markets. Instead of directly investing in oil futures (like the two ETFs do), this ETN is basically a promise from the issuer that they’ll track the performance of oil. That fact adds a lot of risk to OIL – to be precise, it’s known as counterparty risk – because the investment’s performance isn’t just tied to oil, it’s also tied to the financial health of the issuer. We’ll pass on this one…

Commodity ETFs have taken a lot of heat recently because they don’t perfectly track their underlying commodities. In the last 4 months, for example, the spot price of crude oil has risen 36%, while USO has only rallied 28%. One of the biggest reasons for the huge tracking error is what’s known as “roll yield”. Because futures have expiration dates, USO’s administrators have to constantly trade in their old futures for new ones. Unfortunately, because of the way future prices change over time, they often post a small loss on each position as they roll into the next futures contract.

As time goes by, this roll yield adds up to a big discrepancy between the performance of oil and the performance of USO.

But negative roll yields aren’t a problem for DBO. This ETF, which is based on the Deutsche Bank’s Optimum Yield Oil Index, uses the an optimum yield formula to replace expiring futures contracts with contracts that have the highest possible positive roll yield. And even with the added yield advantage, DBO’s expenses are 37% cheaper than USO’s.

While even DBO can’t track the spot price of oil perfectly, the ETF is the only fund worth considering if you want to invest in oil. And the technicals suggest that right now is the time to open a position …

Maximize Your Oil Profits with Smart Timing

For the past five months, DBO has been in a sustained uptrend from its March lows. Currently, there are several very bullish indicators that suggest DBO is going to keep up – or accelerate – its rally. First, onto the chart:

DBO has been trading in a fairly well-defined channel since March, and while this ETF’s current share price is sitting toward the midpoint, a recent bounce off of its 50-day moving average (DBO’s average price over the trailing 50 days) means that the price has a safety net to keep it from tracking back down to the lower bound of the channel.

Translation: DBO will continue to push higher…

Another bullish signal right now is the crossover of the 50-day moving average over the 200-day moving average. That intersection is a leading signal that means a large positive change is underway in this ETF. Given that this is taking place during a big bullish move, it’s a very strong positive signal for traders.

DBO’s Fibonacci retracements are also looking very solid right now…

Fibonacci retracements are a tool used by technical analysts to determine key points of support and resistance using mathematically significant numbers. DBO has bumped off the vertical blue Fibonacci lines six times in its latest rally – which tells me that this ETF is highly influenced by these levels. Right now, it has just broken out above its most recent high (and the 0% retracement level on the graph above). That’s a significant development because it means that there aren’t any obvious stumbling blocks left for DBO to hit.

All of that said, I’d like to see a healthy pullback to either the lower bound of the price channel or either the 50 or 200-day moving averages before taking a position in this ETF.

As usual, the options on this ETF have a much higher profit potential than buying the ETF itself can provide. If your risk tolerance is higher, there are a number of DBO options with a decent trading volume right now.

Cheers,
Jonas Elmerraji

August 7, 2009

The Only Oil ETF Worth Investing In was originally featured in the Penny Sleuth.