Standard One - Futures Market Mechanics

Market Mechanics

When I speak about the prospect of Futures Investment in Malaysia, I often heard about people telling me to stay away from it because it is very risky trading on this kind of investment instrument. The first impression on this subject, it is somewhat true because Futures trading requires advance market interpretation skills, discipline, patience and timing when enter the market. You need to understand what is your risk when pulling the trigger and know aware what kind of return you are expecting from that trade alone. If it sound too good to be true or there is too many greed substance on that trade, you might want to re-evaluate your trading strategy seriously. I would recommend a 1:2 Risk and Reward ratios most of the time. When you missed a trade don't ever try to chase it, it will back fire and burn your equity most of the time. Before I start with my trading mechanism or trade set up, lets look at the possible scenario that can be illustrate in Futures market. 

Illustration 1
Company A has RM10 million in deposits maturing in 4 weeks’ time. John was the financial controller and he wants to change investment strategy and invest this amount in the local stock market. However, he is afraid that the local stock market would have risen by the time he gets the money. In order to “fix” the buying price today, the company carry out an anticipatory hedge and buys the FKLI. Once the money to buy the actual stocks has been released, it can set off its derivatives position and buy his desired equities.

Illustration 2
Peter is a futures index trader and he always does his home work. He found out  that the index futures (FKLI) has been trading at a big premium (Futures index > Cash Index) to the stock market. He decides to arbitrage by selling the derivatives and buying component stocks of the KLCI. By doing so, he has “locked in”his profits and can close out his positions once the gap between both markets return to normal (Futures Index = Cash Index).

Illustration 3

A fund manager has RM30 million invested in the local stock market. To protect against the fall in the stock index and subsequent drop in the value of his equity portfolio, he can hedge by selling the FKLI, selling an OKLI call option or buying an OKLI put option.

More Practical Examples
Trading the FKLI
Simon thinks that the local stock market will fall in line with the overall negative outlook on regional markets. He wants to use this situation to his advantage and decides to enter the FKLI market.
The following table shows his trading strategy and the outcome:
Assumption: Transaction costs not taken into account.
*The formula for calculation of contract value:
Value = No. of lots x Index Price x Value per lot (1 lot = RM50)
Value = 5 lots x 900.00 x RM50 = RM225,000

Trading Set Up- A Guide

Example Of Bullish Market
I am using a very simple method to trade FKLI. Here goes:
1.) Identify what kind of investment horizon you can trade or enter. If you are planning to trade Long Term and Short Term together, make sure you are not confused with the trade sett off for intra-day 1st in 1st out contracts sett off method.
2.) Decide which point you would want to enter and how much you should risk it, make sure your R&R is at least 1:2 !
3.) Check the price action for any significant candle formation and identify the market conditions, Bullish, Bearish, or Flat / Sideways. 
4.) Bullish - 1st Low, higher low, higher low. Bearish - High/Peak, lower high, lower high. Sideways- Based on previous peak and previous bottom.   
5.) Always put a stop for any trades you enter and never change it even your stop loss point is closed to be traded ! Don't feel remorse if your stop loss is triggered. 
6.) Put a Buy Stop if think index is going higher, bullish (After Low, higher Low). Put Sell Stop if you think index / price is going lower or bearish (High, lower High). 
7.)After the order is traded put a stop loss to it, very important !!
8.) Ride the trend, average up if you want based on your equity eligibility and don't forget to take profit no matter how little it is. 
9.) Pay attention to reversal signal or major news that have big impact on the market especially U.S, Europe, China and Japan, and of course Malaysia Stock market. 
10.) Treat your account with respect and guard your equity well.

Every successful or profitable trade usually accompany by trade set up or a plan,
 Constructing trade set up:
1. Short setup on FKLI Nov 09
2. Overall uptrend health on FCPO   

1.) Short setup on FKLI Nov 09
 Short set up on FKLI Nov 09. Today breakout seems valid and there might be a follow through selling right after previous bearish candle. Short set up check list as below:
a.) Breakouts - Check 
b.) Indicator - Check
c.) Divergence - Check
d.) Candlestick formation - Check on Weekly charts 
e.) Recent candle - 2x Check 
f.) Volume -Check
g.) Lower High Or Lower Low - Check 
h.) Market Cycle - Check 
i.) Regional Indices and Sentiment - Check 
j.) Money Management - Check,  Risk = Stop @ 1,255, Reward = 1st Target 1,210, 2nd target = On 20 Points trailing.
k.) SHORT 1 lot @ 1,238, another SHORT @ 1240. (Only by that you pull the trigger)

P/S: On most occasion, not all check because not everything is perfect when you enter a trade.  

Disclaimer: Information and opinions contained in this report are for educational purposes only. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness. No liability can be accepted for any loss that may arise from the use of this article.