Mechanics and Dynamics of Charting
increase the ratio of target size and stopsize over the spread. The most obvious
way to accomplish this is to trade at a higher timeframe or on a larger wave
cycle. The larger the absolute size of the profit target and stoploss, the less will
be the relative cost of trading against the spread. The spread affects the short‐
term trader the most, especially scalpers, and that is why they need to buy at the
bid and sell at the ask price in order to reduce the cost of trading. A standard
level‐one (L1) trading platform will not allow traders to buy at the bid or sell at
the ask price.3.4 Futures Contracts
Futures contracts were originally created to allow commodity producers a
means of hedging against falling prices, and hence they are essentially a bearish
mechanism. By shorting an equal amount in the futures market, producers need
not worry about falling prices during harvest time. They have already locked
in production costs and any potential profit, irrespective of future prices rising
or declining. Depending on when the goods are ready for sale, producers may
choose nearby or further‐out futures contracts to hedge their costs and lock in
any profit.
Unlike equity markets, in the futures market all contracts eventually expire,
requiring the trader who intends to hold on to a position to roll over into the
next available contract. Contracts are available at various expiration months, but
usually every quarter in March, June, September, and December, extending out
beyond a year in many cases.
A futures contract is normally fairly illiquid through its lifespan until the last
three to six months before expiry. Volume and open interest are greatest around two
to three months before expiry. As it approaches expiry, volume subsides as trad-
ers begin rolling over into the next available contract. It should be noted that this
decline in volume toward the expiry of a contract may cause some confusion and
may even lead an analyst to believe that any trend present is potentially weak
due to the decreasing volume and open interest. A quick peek at the next nearby
contract will normally show that volume is in fact increasing over the same period
as traders pile into the next contract. Hence, to gauge the true volume and open
interest action across rollover points, a continuous chart should be employed. See
Figure 3.29.
Figure 3.30 shows the volume over the same period using a continuous
contract. We observe that we are now able to visualize continuity in volume action
across multiple contracts, rather than isolated instances of volume action within
each separate futures contract.
When trying to decide on the most appropriate contract to trade, look for
the contract with the largest volume and open interest. This may not always be
the nearby contract. It is also best to roll over slightly before expiry in order
to avoid the volatility caused by traders exiting at the very last stages of the
contract.
The contract with the closest expiry is referred to as the nearby, nearest, or
front‐month contract. The next available contract further out is referred to as