Finance concessionaire

The trading game is very, very simple. You connect to the internet and log onto your broker's web site. You connect to one of the many futures market places.

A futures market is based on something that tends to change in value continuously during the trading day; the Dow Jones stock index, for example.

You are presented with two buttons on your screen: - Buy and Sell. (There are actually many different ways you can enter Buy/Sell orders, but we will keep it simple here.)

If you want to bet that the index value will go up, press the Buy button. You are now in play. You can end this trade at any time you like by pressing the Sell button. This is a Long trade.

If you want to bet that the index value will go down, press the Sell button first. That starts your trade. You can end it at any time by pressing the Buy button. This is a Short Trade.

Continuing the Dow Jones example, we will assume that each index point is worth $5.

You think the market is moving up and decide to take a Long trade. You press the Buy button when the index is at, say, 11,600. You are right and 20 minutes later the index is at 11,640. You press the Sell button, making $200 profit. (The index went up 40 points at $5 per point.)

Suppose you were wrong, and after 5 minutes you see the index has dropped to 11,580. You press the Sell button and close the trade with a $100 loss. (The index dropped 20 points losing $5 per point.)

If you think the market is looking weak, you might decide to take a Short trade. You press the Sell button with the index at 11,600. You are right. An hour later the index has plummeted 100 points to 11,500. You do not think it will fall any further, so you press the Buy button to close the trade, and you book $500 profit. (The market has dropped 100 points at $5 per point.)

If you were wrong and 20 minutes after you start the trade the market is up 30 points, you could decide to exit the trade by pressing the Buy button and taking the 30 point ($150) loss. (You bet the market would drop, but it has gone up 30 points losing $5 per point.)

Trading financial instruments (futures, options, shares) has a lot in common with gambling. The essential difference is that it is possible for you to design your own playing strategies which give you a statistical edge over time. In gambling, the casino always has the edge.

Success at day trading futures contracts has almost nothing to do with your knowledge of finance and markets; there is no need to waste time reading financial pages, reviews of market action or watching CNBC.

The broad context of the game is the same for everybody:

Buy (go long) and sell at a higher price for a profit.

Sell (go short) and buy back at a lower price for a profit.

If you go long and the price falls, you make a loss.

If you go short and the price rises, you make a loss.

The challenge in the game is that price seldom moves directly in one direction or the other. Normally it moves up and down in an apparently haphazard manner driven by (1) the economic fundamentals of the market, and (2) the short term actions of other game players.

Short term futures traders do not usually study the economic fundamentals. Instead, they learn to analyse price charts and understand the various strategies that other traders employ. This lets them define situations where they can enter the market with a high probability of success, and a low level of risk.

Because the price moves up and down, you (the player) often have to make a choice between risk and potential profit. Suppose you bet the price will rise (go Long) and the price suddenly falls a bit. Do you hold on and wait for the price to turn round and move up as you expected, or do you sell and take a loss? How much risk are you willing to take?

Similarly, maybe you bet the price would fall (go Short). But the price suddenly makes a swing up. Is this just a temporary random swing, or is it a significant change? How much can you afford to risk before you get out of the trade at a loss?

What if you bet the price would go down and it does! In fact, the price plummets and you have a huge profit. Do you close the trade now and grab your profit, or hold on until the price falls further and your profit increases? (The risk here is that the price will rise again, and your paper profits will disappear.)

Because markets move in such a haphazard manner, nearly all winning trades will have been in a loss position at some point. So the question of how much risk you are willing to bear is a vital one.

To recap, the mechanics of the game are simple. All you need is to be connected to a market and have the ability to take two simple actions: Buy or Sell.

Because the rules of the game are simple, do not be mislead into thinking it is a simple game. The ancient board game Go has very simple rules. Almost anybody can play after a few minutes' tuition. But to play it well, that is a different matter! Trading is like that....

Notes

To a short term trader it makes practically no difference what the underlying commodity is. I looked at the Dow Jones contract, but there are dozens of different contracts to choose from. For example, the contract may be based on the price per bushel of soybeans, or the exchange rate between the US dollar and the yen.

You have to have a certain amount of money deposited in your trading account before the broker lets you to play. This is called the margin. It is not always the same. As an example the margin for one soybean contract is $675 at my broker (day trading), but it is $1406 for one Dow Jones contract, which is perceived to be more risky. The margin is there to protect the broker if you lose.

The broker charges you a fee every time you press the Buy or Sell button. This is the brokerage fee. My broker charges me $2.40 for the privilege.

If you are losing on a trade you may reach a point where your balance no longer covers the required margin for the position you are in. At this point, your broker may either close your position without consulting you, or contact you requesting that you immediately deposit more money to cover the margin. This is a margin call.