Commodity Futures Trading for Beginners

By Bruce Babcock

Making a Trade

Assuming the trader has consulted his price charts, applied his trading plan's decision-making criteria and decided to make a trade, how does this actually take place? He will have a trading account open with a broker. Believing, for example, that the price of Silver will be going up in the near future, he calls his broker's trading desk, and the following conversation might occur.

        "XYZ Discount Brokerage.

        "This is Bruce Babcock. For account number 22656,
        buy one December Silver at the market."

        "Buying one December Silver at the market. Please hold."

The broker may enter the order into a computer or she may call the exchange floor directly. In either case, the order goes to the exchange trading floor in New York City. Once at the broker's desk on the edge of the trading floor, a runner may take the order to the trading pit to be filled or a clerk may transmit it to the pit by hand signals. In the trading pit, a floor broker executes the order with his fellow floor traders by a combination of shouting and hand signals. The process is then reversed as the trade price is communicated back to the customer.

        "Hello. You bought one December Silver at 550."

        "I would like to enter my stop order. Good 'til canceled,
        sell one December Silver at 540 stop."

        “For account number 22656, selling one December Silver
        at 540 stop. Good 'til canceled."

        "Thank you."

The second sell order was an instruction to the broker to automatically offset the trade if Silver declined in price by $500. This was a prudent step to limit the loss in case price did not go up as the trader expected. Placing the order with the broker means that the trader will not have to monitor the market constantly to be sure the loss does not get too big if price goes down instead of up. The trader is not guaranteed to limit his loss to exactly $500, but he will usually be able offset his position fairly close to the requested price.

The trader can offset his position any time before the Silver contract expires in December. To the extent Silver's price is more than $5.50 an ounce when he offsets, the trader will profit by $50 for each cent. To the extent Silver's price is less than $5.50 when he offsets, the trader will lose $50 for each cent.
To do the same trade with less dollar risk, the trader could have instructed the broker to place the orders at the Mid America Exchange, where the Silver futures contract is only one-fifth the size of the regular New York contract. That would have yielded profits and losses of $10 for each cent rather than $50.

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TRADING IN COMMODITY FUTURES OR OPTIONS INVOLVES SUBSTANTIAL RISK OF LOSS.
PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

[ CFTC RISK STATEMENT ]

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