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Chapter 1. Basic training: a futures primer

Chapter 1. Basic training: a futures primer

Picking up the phone and instructing your broker to buy or sell is relatively simple. Performing a few mouse clicks and transmitting your order to a handheld device in the pit or to a totally electronic marketplace isn't all that hard either. It's really not all that difficult to understand how the money works. What is difficult, however, is extracting profits from the markets (something we'll tackle later in this book), but you have to start somewhere. This chapter is for those of you who need to learn the basics. So here we begin, as good a place to start as any.

Commodities are not only essential to life, but they are absolutely necessary for quality of life. Every person eats. Billions of dollars of agricultural products are traded daily on the world's commodity exchanges—everything from soybeans to rice, corn, wheat, beef, pork, cocoa, coffee, sugar, and orange juice. Food is where the commodity exchanges began.

In the middle of the nineteenth century in the United States, businessmen started organizing market forums to facilitate the buying and selling of agricultural commodities. Over time, farmers and grain merchants met in central marketplaces to set quality and quantity standards and to establish rules of business. In the course of only a few decades, more than 1,600 Exchanges sprung up at major railheads, inland water ports, and seaports. In the early twentieth century, as communications and transportation became more efficient, centralized warehouses were constructed in major urban centers such as Chicago. Business became less regional, more national; many of the smaller Exchanges disappeared.

In today's global marketplace, approximately 30 major Exchanges remain, with 80% of the world's business conducted on about a dozen of them. Just about every major commodity vital to commerce, and therefore to life, is represented. Billions of dollars worth of energy products—from heating oil to gasoline to natural gas and electricity—are traded every business day. How could we live without industrial metals (copper, aluminum, zinc, lead, palladium, nickel, and tin); precious metals such as gold; or platinum and silver, which are considered both industrial and precious metals? How could we live without wood products or textiles? It would be hard to imagine life without them, and yet few people are aware of just how the prices for these vital components of life are set. Unlike 100 years ago, today the world's futures Exchanges also trade financial products essential to the global economic function. From currencies to interest rate futures to stock market indices, more money changes hands on the world's commodity exchanges every day than on all the world's stock markets combined.

Governments allow commodity exchanges to exist so that producers and users of commodities can hedge their price risks. However, without the speculator, the system would not work. Anyone can be a speculator, and contrary to popular belief, I do not believe the odds need be stacked against the individual. In this book, I plan to share with you techniques designed to help you make money trading commodities. Actually, you as an individual have one distinct advantage over the big players, and that's flexibility. You can move quickly, like a cat, something a giant corporation can't do. Many times, several of the big commercial operators that utilize the Exchange for hedging literally hand you your profits on a silver platter—they're there for a different reason. So, let's start by looking at how the futures contract works and the various participants in the marketplace. We'll also look at what they are attempting to accomplish and how they interact with each other.

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