Futures

This Little Piggy Went to the Market

dondawson
Don Dawson
Instructor

And This Little Piggy Went to the Market.  But on the way he stopped at your house and took your money because he wanted to buy a new large screen television for his new brick home he had built recently to protect him from the big bad wolf. Don’t you love fairy tales?

This article is about an event that happened in the Lean Hog Futures market a couple of months ago that I thought our readers should be aware of. It’s a rare event in today’s Futures markets. The event is a Limit Move in Commodity prices.

A Limit Move is a price restriction that Futures Exchanges put on some Commodity markets and not others. Each day the Exchange will take the previous day’s settlement price and add and subtract a fixed price. Thereby creating a high and low maximum price band the market may trade out to the next trading session.

For example the Lean Hog market has a daily Limit Move of .03 above and below the previous trading session’s settlement price.

Market

Table 1

Once price trades to one of these Limit prices the market is not allowed to trade beyond that price. If price trades to Limit Up market participants are permitted to sell at that price, but they cannot buy any higher than the Limit Up price. I will explain later why it is not smart to sell when markets are Limit up or buy when markets are Limit Down.

A trader should be aware of Limit Moves in the particular Futures markets they are trading. This is the individual trader’s responsibility, not your brokers. Once your broker contacts you about a Limit Move it is usually because you are getting a margin call (requesting you send more money to fund your trading account because you just lost a lot of money). Each Futures contract has specific contract specifications and these can be found on the Exchange’s website where the market trades. This is where you will find if your market has a daily price limit. If there is no daily price limit for your market the Exchange will just omit that line from the specifications.

Many markets have Limit Moves on a regular basis and during the next session the market begins to freely trade in both directions again normally after a gap opening. The rare event I was mentioning earlier is a day when the market goes Limit Up or Limit Down and when the next session opens, it gaps up or down the next day’s daily limit and does not trade for the entire session, for both Extended and Regular Trading hours. This traps many traders in the market and they cannot liquidate their losing positions until the market begins trading again. The Lean Hog market did exactly this and I would like to show you some charts of what it looks like and what the risk was to traders on the wrong side of the market.

Figure 1 is a 45 minute Regular Trading Hours (RTH) chart of the October Lean Hog market.

image001

Fig 1

The blue box represents where the Lean Hog contract gapped into a Limit Up price and never traded all day. If you look at an Extended Trading Hours (ETH) chart you will see the market was Limit Up during that entire session as well. If a trader were short prior to this Limit Up Gap they could not get out of their position until somebody was willing to sell at the Limit Up price. Unfortunately it is very rare that anybody will sell to you when markets are Limit Up. They are well aware that what made price go Limit Up was a huge imbalance of buyers to sellers. Therefore when the market resumes trading the next session the odds are the market will gap up and that is when the traders with short positions can attempt to exit the market

Figure 2 will show a daily chart of the same market.

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Fig 2

The dangers of these Limit Moves is that sometimes a Supply/Demand level may have you enter the market for a swing trade. Then as in this example the market gaps past your stop and is immediately Limit Up. Meaning you’re trapped in your short position.

The chart above shows what could have happened to a trader if they were short (for any style of trader) on June 27, 2014 @ 111.550. The lower blue arrow shows the day a trader may have gone short. The next session the market gapped Limit Up and stayed there for the entire session. The stop the trader may have had in the market was gapped through and could not be filled the next trading session. Then on July 1, 2014 the market gapped up and began trading. At this point any stops that were trapped in the Limit Up will be filled at or near the opening price of 115.150.

Each $1.00 move in the Lean Hog market is worth $400. If the trader was filled on the open of this candle the math would look like this:

115.15 (Stop Fill) – 111.550 (Short from) = 3.60

3.60 * $400 = $1,440 loss

Perhaps the trader entered the position with the assumption their stop was only risking a couple of hundred dollars, but after the Limit Up move against them they actually lost $1,440 per contract.

While these types of Limit Moves are rare today, they can still happen. For a small trader this could actually result in them losing more money than they have in their trading account and they would be responsible for the extra loss beyond their cash balance.

Understanding the Futures markets you choose to trade is very important. Technical analysis is only a small part of becoming a successful trader. To be a complete trader you must understand contract specifications and the risk you are facing in certain markets.

“What you get by achieving your goals is not as important as what you become by achieving your goals.” Wolfgang Goethe

– 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.