Removing a Charting Mystery
Removing a Charting Mystery
All Commodity Futures contracts have an expiration date for which that contract ceases to exist and the trading volume moves on to the next contract month of the Commodity. Unlike a Stock that has no expiration, this creates a few challenges to the Commodity trader. The question soon becomes, "Which chart do I trade Commodities on - Continuous or Contract Specific?" Actually, we will use both, but depending on which contract month you are trading will determine which one to use.
Let's define these two types of charts:
- Continuous charts
- Contract Specific charts
Figure 1 will illustrate a Continuous chart of Crude Oil. To construct a Continuous chart, the software vendors will determine a cutoff date for when they will quit plotting a particular contract month on the chart. Normally, this occurs approximately 7 ñ 10 trading days before the contract actually expires, also known as the rollover day. Once this rollover occurs, the software vendors will keep all the historical data for that Commodity and begin plotting the next front month contract (contract with the most volume and open interest) prices on the same chart. These prices are updated until this contract expires and the process starts all over. This creates a continuation of prices as if there was never an expiration of a contract. The results are a chart that looks similar to a Stock chart that never expires and has many years of historical data available for research. Using Continuous charts allows us to see longer term weekly and monthly charts for significant supply and demand levels.
Figure 1
Figure 2 will show a Contract Specific chart of Crude Oil for August 2011 delivery. This type of chart has its place in the trader's arsenal as we will discuss later. However, looking at this chart, we can see that data on the far left of the chart is very illiquid and not easily used to find supply and demand levels. Once a contract month gets closer to becoming the front month contract, the chart starts looking more fluid and more definable levels are evident.
Figure 2
Many of you have heard of adjusted and un-adjusted Continuous charts in the Futures markets. In a previous article I wrote in June of 2010 titled, Futures Charting ñ Adusted or Un-Adjusted Charting Style?, I go into more details about the differences and uses of these two styles of Continuous charts.
Now, let's clarify which chart we want to use for trading the Commodity markets. The only chart I would use for Continuous charts is the un-adjusted type. These charts plot the actual prices that traded when a contract was the front month. There are no adjustments to the prices so supply and demand levels are accurate. Personally, I would never use an adjusted chart for identifying levels. The price scale is adjusted with each contract expiration and this distorts the price levels. Figure 3 will illustrate this fact. Here is an adjusted continuous contract of Crude Oil. Notice the high price of Crude Oil in 2008 on this chart shows a high of $191.00. I think we can all remember that move in Crude Oil and it terminated at $147 on un-adjusted Continuous charts.
Figure 3
The construction of a Continuous chart is always plotting the front month contract with the most volume and open interest. For every chart high and low we see on these charts means the front month at that time traded to these levels. Front months in Commodities are often referred to as Spot or Cash prices. This means that the Futures contract will closely track the Cash price of that particular Commodity, unlike back months that are trading and have carrying charges added to them.
My rule for trading the Commodity markets is that for any trade I am in and it involves the front month contract, I will use the un-adjusted continuous Futures contract to identify levels and trends.
Anytime I trade a Seasonal pattern and it involves trading a back month, I will use the Contract Specific chart to create those levels and trends. For example, if the current front month of Crude Oil is August and there is a Seasonal sell in the December contract, I will use the December contract to identify levels for my entry, not the un-adjusted Continuous chart.
These are my rules for which charts to use. Just like everything else in life, there will be people who agree with me and then some who disagree. The key I have found is to pick rules that work for you and be consistent with them.
"The Big Lesson - The people who make a difference in your life are not the ones with the most credentials, the most money or the most awards. They are the ones that care." Michael Dlouhy
Good Trading Everyone, Don Dawson
About Don Dawson
Don has been trading the futures markets for 20 years. His perseverance through the ups and downs of trading, openness to experience of others, balanced tolerance for risk and patience to wait for his setups are a few of his strengths as a trader. He is excited about sharing his passion for trading with others. A quote he likes is "A candle loses nothing by lighting another candle." He is now looking for a balance in life between trading and teaching others what he has learned from 20 years of trading. He acknowledges that the best teacher is a student ñ always in learning mode and wanting to learn more by teaching. He looks forward to working with each of you in one of his E-mini Futures classes. He is also writing articles for Online Trading Academy's free newsletter "Lessons From the Pros" and hopes students find this a valuable resource.
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