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What Can Stock Traders Learn From Futures Traders? Plenty.

<I>The Futures Game</I> provides some valuable lessons for all traders.

Richard J. Teweles and Frank J. Jones, edited by Ben Warwick, The Futures Game, Who Wins? Who Loses? And Why?, Third Edition, McGraw-Hill, 1998, 750 pages, $49.95

Traders who normally concentrate solely on equities often have an interest in what "the market" is doing. But that very market can only be traded as a futures contract in the form of the

S&P 500


New York Composite Index

, the

Value Line Composite Index

or the

Dow Jones Industrial Average

, newly introduced last year. Options on these indices exist, but they offer a different kind of trade.

So if you want to trade the market, you have to learn futures market conventions, rules and lingo. This is often thought of as a daunting prospect, but it shouldn't be. As the authors of

The Futures Game

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write, people believe that the mechanics of futures trading are more complicated than they really are. In fact, trading futures is simpler than trading equities.

It may come as a surprise that a great deal more information is available in futures markets than in equity trading. For one thing, the exchanges publish the long and short positions of both hedgers and speculators, big and small, thus defining the demand side. On the supply side, both government and private sources publish tons of data on agriculture, metals, etc.

Moreover, futures markets participants are highly advanced in both fundamental and technical analysis, as well as so-called intermarket analysis, which explores the relationships between bond prices and stock prices, and between commodity prices and the performance of industry sectors. Teweles and Jones also provide a thorough review of the three main trading strategies -- fundamental, technical and spread-based trading -- as well as the myriad strategies possible in trading options on futures.

They also spend some time on various efficient market theories, which may reveal Teweles' academic background rather than a real day-to-day concern in the market. The important point to take away is that futures markets are as close as you can get to classical "pure" free markets, with full information known to all -- quite a contrast to equities, whose prices move on imperfect information and sometimes no information at all.

This has important ramifications, as can be gleaned from the "who wins, who loses and why" section. It has been completely rewritten and updated by editor Ben Warwick with some recent studies. The book cites a handful of them, which show that while "small investors" as a group hold 46% of the value of all contracts, they are net losers on average in most years. This is only partly offset by the fact that they are impressive winners in some years.

The group of large speculators, on the other hand, makes both sizable and consistent profits. What's their secret? They view the markets as "trading" markets, rather than "trending" markets. In short, they don't fall in love with their theories or their positions, and cut their losses short while letting profits run.

Why small traders lose money -- and the futures markets have a bad name as a consequence -- is not because the futures market is rigged against them, as some may think. It is precisely because they lack a key ingredient available to the pros called, simply, money management discipline. Acknowledging that one is a speculator -- as all futures traders are -- is self-liberating in that it concentrates the mind wonderfully on valuable techniques like having a stop-loss level, and a profit target.

This very topic is one of the key contributions of futures trading -- and a strength of this book. This new science uses the calculation of underlying risk and return to help traders determine both their trading strategies and tactics. This is a subject ignored by most books on "investing" but a key to trading futures. The authors introduce the concept of "expectation of the game played," which is the only way to think about participating in any market. There is also discussion about the probability of ruin.

Put the two together, and you have both a trading plan and a money management plan. The authors make it clear that the biggest mistake in trading is not to have a plan, and the second biggest is not to follow it. This section could benefit from even more of the same; since the book's first printing in 1984, a lot of work has come out on the mathematics of money management. Most of it is indigestible by all but a few of the mathematically inclined, but in any case, the leading-edge work is being done in futures, not equities.

Barbara Rockefeller is the principal behind Rockefeller Treasury Services, a Stamford, Conn.-based independent research firm specializing in foreign exchange forecasting and best-practices currency management. A former currency risk manager for Citibank, European American Bank and Brown Brothers Harriman, Rockefeller has advised major multinational corporations and global fund managers since she founded RTS in 1991. At time of publication, she held no positions in any currencies or instruments mentioned in this column, although holdings can change at any time. She can be reached at her investing

Web site, or via email at has a revenue-sharing relationship with under which it receives a portion of the revenue from Amazon purchases by customers directed there from TSC.