Important Preliminaries

What you learn in this book can be put to use immediately. You will not be subjected to any "hocus-pocus" by word or deed.

You will be pleasantly surprised to know that there are no fj algebraic equations any place in this book. Most people I have met cannot work with that type of math, so out it goes, with no loss at all to you. If you can do simple arithmetic, composed of addition, subtraction, multiplication and division, I will make an effective futures trader out of you. The simple arithmetic, and I stress the word simple, can be done by hand or with a $5.00 calculator. The only difference is that the calculator is faster.

A caveat: As you study, try not to let your mind wander. If you have experience with bar charts, P&F charts, moving averages, oscillators, technical formations, etc., don't think about them. They do not have anything to do with this study. We do use graphs, but they do not incorporate the aforementioned factors.

It is further suggested that you refrain from "fine tuning" the techniques herein. Certainly they are not the absolute, ultimate and only way as they stand, I'm not that vain. But they do work. Learn first, experiment later. In other words, get the theory, the basics, the procedures down pat. Then, if you so choose, improvise. But do yourself a favor, DO IT ON PAPER FIRST!

What you will be studying is a methodology which can be applied to any futures contract listed on any exchange, and any futures contract which is not presently listed.

You see, the methodology or theory is based on measuring the emotions of traders. It does not matter if they are trading T-bonds, sugar, grains, or whatever. Their emotions, which are reflected in their buying and selling decisions (and the strength or conviction of same, by their amout of trading), will tell you what is about to happen to the futures price. That is your edge when you take a position in the futures contract.

The daily price gyrations can play havoc with the emotions of traders. Value, price and worth, therefore, should be understood and placed in proper perspective.

Value is our perception of what something is worth. Price is the amount we are willing to pay for worth. What do worth and price have to do with attempting to project a price trend?

Worth is subjective. That is, we judge worth by the degree of need. How much do we need the wheat? The cumulative effects of the judgement of worth are reflected in the price we are ready to pay for that wheat. Hence, the price is but a reflection of the worth of a product. No more, no less.

If worth, to some extent, is subjective, we have the first part of the theory behind the trading methodology. From the subjectivity of how one values worth, we add actual or perceived needs for the product. We then marry the elements, which, in turn, become demand. How much do we think will be needed and how much will we actually require? The end result is not an absolute, due to events over which we have no control, such as weather, or government interference, etc.

Since nature is oftentimes uncooperative, we cannot be certain that our future needs will be met. This is the core behind price movements which may seem out of line: our subjective and actual needs become "worthier" and we are willing to pay a higher price to insure an adequate supply of the commodity at the time it is needed.

Worth is eventually translated into action. Specifically, we will purchase a futures contract to insure delivery at the proper time. Conversely, other users may determine that the worth (to them) is too high and will offer (sell) the futures contract for delivery at some time in the future for a stipulated price.

It is apparent, therefore, that the degree of worth must be measured to profit in the trading of commodity futures. Measuring worth (open interest) and its relationship to value (price) is the concept behind the development of my method. As you work through this book, keep in mind that it is worth f which determines price and not the other way around. This worth effects the valuation of the futures contract price.

Open interest in a futures contract represents an equal number of longs and shorts. For every long side of a contract, there is a short side. In other words, for each trader who is long a contract, there is a trader who is short the same contract. Each side of the contract is claimed by someone, so to speak. It would seem that, price-wise, we are at an impasse—one long •I trader who believes the price is going higher and one short \ trader who believes the price is going lower. A stalemate, or so h would seem.

What is the catalyst that gets the price moving? In one 7 word—fear. A buyer (long) of a futures contract goes long because he fears that the price will move higher and he will miss a potential "long" profit. A trader who is short the same ¿contract is short because he fears that he will lose a potential profit if the price goes down without him. What gets the price moving is whose fear is stronger.

i The question I asked was: "If the fear quotient of the buyer 7 (long) is stronger than that of the seller (short), what would be the result?" I then proceeded to turn the question around, "If «the fear quotient of the seller is higher than that of the buyer, i what then would be the result, price-wise?" The next question c is, "How do I measure the fear quotient to take advantage of f the dichotomy?"

The answer to the first question: If the buyer's fear quotient is higher than that of the seller, the buyer will increase his bid

(pay a higher price) for the futures contract. This will drive the price of the contract up. If the seller's fear quotient is higher than that of the buyer, the seller (short side) will accept a lower price, reasoning that the price has further to fall and he, in turn will profit. If this is the prevailing attitude in the market, the price will fall. This answers the second question.

The answer to the third question is a little more involved. For one thing, the fear relationship of the traders on the long and short side of the contract is complicated by the often false signals of the closing price. Using the closing price alone as an indicator of fear will have you running around in circles. A closing price, on any given day, can do one of three things relative to the previous day's closing price: it can close higher, lower or unchanged.

The unreliability of the closing price as a true indicator of fear forces us to look elsewhere. I turned my attention to the often-times wide price fluctuations of intra-day trading, fluctuations which sometimes reached limit proportions up and down. These intra-day swings, as it turned out, were the barometer of the degree of fear, relative to anticipated future price action—irrespective of the closing price!

Based on my theory that fear moves contract prices, you will learn how to obtain, graph and use a fear index, applied to individual futures contracts so as to profitably trade any of them.

I will, in fact, call this a Power Index. Based on fear, it shows who (buyers or sellers) has the power in the market. It also is a good indicator of how much power they have. And consequently, how strong each up or down move will be.

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