Futures

Charting the Correct Month of a Futures Contract

dondawson
Don Dawson
Instructor

As a Futures trader it is important to know what the front month contract is.  We can determine this by finding the contract month with the most volume.  As speculators we need to trade in months with the highest volume to provide us better liquidity for both entering and exiting our trades.  Also, the month with the most volume will create charts with better levels simply because of more trading activity.

Trade Station users will typically use a symbol like @S=110XN for their un-adjusted continuous charts.  This symbol tells the Trade Station software to create an un-adjusted continuous chart for the Soybean market that rolls over automatically 10 trading days before the contract expires.  For many markets this symbol works fine because every month that the Exchange offers for that Commodity is a high volume month.  However there are some Commodity Futures that have contract months listed by the Exchange, but they do not have enough volume to become a front month.  I will address which of these markets are impacted further into the article.

One of these markets is the Soybean market.  Using the symbol @S=110XN has a flaw during the trading year.  Soybean contracts are available for the following months each year to trade – January, March, May, July, August, September and November.  As I am writing this the July contract is ready to expire so there are no speculators trading this contract until it expires.  The next months in the contract cycles are August and September.  If a trader using Trade Station were to use the symbol @S=110XN their charts would be putting the August Soybean prices on their continuous charts.  And once August expires then it would be putting the September prices on their continuous charts, just like a continuous chart is supposed to do.  The problem is the volume for these contracts are very low and the largest volume is now in the November Soybean contract making it the front month we should be trading in.

Why does the Exchange have a month listed for trading, but the volume is so low?

The Soybean markets as well as other Grain markets have something called Old Crop and New Crop years.  Old crop refers to Grain that was harvested in the prior harvest season and kept in Grain elevators to be sold during winter months and for a portion of the next growing season.  New crop refers to the current year’s harvest which for Soybeans will be completed by November.  During the early winter months and late Spring the Grain elevators storing these Grains use the January, March, May and July contracts for hedging this old crop they have in their inventory.  By the time August and September comes most of the old crop has been hedged and the market is awaiting the new crop for November delivery.  Therefore there is very little need or use for the August or September Futures contracts, usually. This year the market was shocked by a U.S.D.A (United States Department of Agriculture) report showing that last year’s crop yielded about 44 bushels per acre, much higher than anticipated.  (This also will support the estimate that the new crop will be near 45 bushels per acre).  When this report came out Grain elevators were more than happy to use the remaining old crop contracts to hedge with.  But from the speculator standpoint the largest volume remains in November Soybeans and that is where speculators should be trading.

In the end it is always about the Commercials when it comes to trading Futures.  Once you have a better understanding of how they use Futures contracts for hedging you can see which contract months are their preferred choices.

How do we trade November Soybeans on a continuous chart when the software is plotting the August prices?

We must use a different type of Futures symbol to get the software to only plot the highest volume contract months on our charts.  For our Soybean example we need to add some characters to the @S=110XN symbol.  Once we add these symbols you never have to change them because they are consistent year after year.

Table 1 will provide a list of markets that need to have these symbol adjustments:

Market

Symbol

Gold

@GC=120XN+GJMQZ

Silver

@SI=120XN+HKNZ

Corn

@C=110XN+HKNZ

Wheat

@W=110XN+HKNZ

Soybeans

@S=110XN+FHKNX

Soybean Meal

@SM=110XN+FHKNVZ

Soybean Oil

@BO=110XN+FHKNQVZ

Cotton

@CT=110XN+HKNZ

Orange Juice

@OJ=108XN+FHKNX

Lean Hogs

@LH=109XN+GJMQVZ

Live Cattle

@LC=117XN+GJMQVZ

Table 1

Enter the symbols just like you see them including all characters.

I have written various articles in the past about the differences between contract specific, un-adjusted continuous, adjusted continuous and contract specific continuous charting.  In this article I would like to address how to setup your un-adjusted continuous charts that only plot the most active trading months during the calendar year.

Figure 1 is a chart of the Gold market using the symbol @GC=120XN.  The Exchanges offer an October contract for delivery.  There is very little volume and open interest in this particular month, but the software will plot these anyway.  Look at the poor liquidity causing gaps and low quality candles. (I used the Gold illustration because once the upcoming August Gold contract expires we need to skip the October Gold contract)

20140722 poor liquidity causing gaps and low quality candlesFig 1

 To eliminate this problem a trader needs to adjust the symbol to chart only months that have the most volume and open interest.  To see Gold trading with the most active contract month a trader using Trade Station should use the symbol @GC=120XN+GJMQZ   Notice the letter V is missing from this list of contract months.  This tells Trade Station that when August Gold nears expiration then skip the October Gold contract month and go directly to the December Gold contract.

20140722 gold and lack of gaps

Fig 2

Figure 2 shows a chart of Gold during the same time period as Figure 1, but notice the difference in the quality of the candles and lack of gaps.

If you trade these markets and use Trade Station I would recommend you update your radar screen with these symbols.  If you are using another chart package you may want to confirm what month is being plotted on your continuous charts.  Compare the price of the highest volume contract to the price you see on your continuous chart and if they match you are fine.  If there is a discrepancy then you may have to contact your chart provider to help you setup your charts correctly.

Another question that seems to be coming up frequently is, “Which type of chart should I use?”  The confusion seems to come from whether they should use a contract specific chart or a continuous chart to create their levels from.  The answer is either will work fine as long as you use the same one consistently.  If you try and draw levels on two different styles of charts there is a good chance they won’t line up.  Then the trader is faced with paralysis of analysis because they see both levels.

The only hard rule I have is when it comes to Financial Futures (Stock Indexes, Interest Rates and Currency Markets) I “ALWAYS WITHOUT A DOUBT” will use an un-adjusted continuous contract for finding levels and “NEVER” a contract specific chart.  This means all year long I use the same style chart for these markets and make no exceptions because it is contract rollover time.

Each trader can decide if they want to use a contract specific or continuous chart for other Commodity markets, but just be consistent and don’t jump around looking for levels.  If you do not find a level on the chart you use all the time then there is no trade, don’t force a trade by switching charts.

I received this quote from an OTA Graduate and thought I would share it with you.

“No failure – only feedback”

–      Don Dawson

 

Disclaimer
This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.