natural wave trading theory[1]

8/14/2019 Natural Wave Trading Theory[1]

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Natural Wave TradingTheory

Club Member Manual

2000-2009 Natural Wave Trading TheoryAll Rights Reserved.

No portion of this manual may be copied or reproduced in any form without written permission.For more information contact: [email protected]


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Natural Wave Trading Theory 2

DISCLAIMER:

The opinions expressed herein are based on our judgment and our experience ofcommodities, futures and options. We do not guarantee that profits will beachieved, or that any losses will be incurred. These opinions should not beconstrued as an offer to buy or sell commodities. Commodities and futurestrading involves risk and is not necessarily appropriate for all investors. Pastperformance is not necessarily indicative of future results. Consult commoditiesprofessionals before placing real trades.


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RISK DISCLOSURE STATEMENT

THE RISK OF LOSS IN TRADING COMMODITIES CAN BE SUBSTANTIAL. YOU

SHOULD THEREFORE CAREFULLY CONSIDER WHETHER SUCH TRADING IS

SUITABLE FOR YOU IN LIGHT OF YOUR FINANCIAL CONDITION. IN

CONSIDERING WHETHER TO TRADE OR TO AUTHORIZE SOMEONE ELSE TO

TRADE FOR YOU, YOU SHOULD BE AWARE OF THE FOLLOWING:

IF YOU PURCHASE A COMMODITY OPTION YOU MAY SUSTAIN A

TOTAL LOSS OF THE PREMIUM AND OF ALL TRANSACTION COSTS.

IF YOU PURCHASE OR SELL A COMMODITY FUTURE OR SELL A

COMMODITY OPTION, YOU MAY SUSTAIN A TOTAL LOSS OF THE

INITIAL MARGIN FUNDS AND ANY ADDITIONAL FUNDS THAT YOU

DEPOSIT WITH YOUR BROKER TO ESTABLISH OR MAINTAIN YOUR

POSITION. IF THE MARKET MOVES AGAINST YOUR POSITION, YOU

MAY BE CALLED UPON BY YOUR BROKER TO DEPOSIT A SUBSTANTIAL

AMOUNT OF ADDITIONAL MARGIN FUNDS, ON SHORT NOTICE, IN

ORDER TO MAINTAIN YOUR POSITION. IF YOU DO NOT PROVIDE THE

REQUIRED FUNDS WITHIN THE PRESCRIBED TIME, YOUR POSITION

MAY BE LIQUIDATED AT A LOSS, AND YOU WILL BE LIABLE FOR ANY

RESULTING DEFICIT IN YOUR ACCOUNT.

UNDER CERTAIN MARKET CONDITIONS YOU MAY FIND IT DIFFICULT

OR IMPOSSIBLE TO LIQUIDATE A POSITION. THIS CAN OCCUR, FOR

EXAMPLE, WHEN A MARKET MAKES A LIMIT MOVE.

THE PLACEMENT OF CONTINGENT ORDERS BY YOU OR YOUR

TRADING ADVISOR, SUCH AS A STOP LOSS OR STOP LIMIT

ORDER, WILL NOT NECESSARILY LIMIT YOUR LOSSES TO THE

INTENDED AMOUNTS, SINCE MARKET CONDITIONS MAY MAKE IT

IMPOSSIBLE TO EXECUTE SUCH ORDERS.

A SPREAD POSITION MAY NOT BE LESS RISKY THAN A SIMPLE

LONG OR SHORT POSITION.

THE HIGH DEGREE OF LEVERAGE THAT IS OFTEN OBTAINABLE IN

COMMODITY TRADING CAN WORK AGAINST YOU, AS WELL AS FOR

YOU. THE USE OF LEVERAGE CAN LEAD TO LARGE LOSSES AS WELL

AS GAINS.

IN SOME CASES, MANAGED COMMODITY ACCOUNTS ARE SUBJECT TO

SUBSTANTIAL CHARGES FOR MANAGEMENT AND ADVISORY FEES. IT MAY

BE NECESSARY FOR THOSE ACCOUNTS THAT ARE SUBJECT TO THESE

CHARGES TO MAKE SUBSTANTIAL TRADING PROFITS TO AVOID DEPLETION

OR EXHAUSTION OF THEIR ASSETS.

THIS BRIEF STATEMENT CANNOT DISCLOSE ALL THE RISKS AND OTHER

SIGNIFICANT ASPECTS OF THE COMMODITY MARKETS. YOU SHOULD

THEREFORE CAREFULLY STUDY ADVISORS DISCLOSURE DOCUMENT AND

COMMODITY TRADING BEFORE YOU TRADE INCLUDING THE DESCRIPTION

OF THE PRINCIPAL RISK FACTORS OF SUCH INVESTMENT.


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A COMMODITY TRADING ADVISOR IS PROHIBITED BY LAW FROM

ACCEPTING FUNDS IN THE TRADING ADVISORS NAME FROM A CLIENT FOR

TRADING COMMODITY INTERESTS. YOU MUST PLACE ALL FUNDS FOR

TRADING IN THIS TRADING PROGRAM DIRECTLY WITH A FUTURES

COMMISSION MERCHANT.


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C O N T E N T S

INTRODUCTION 6

1. GETTING STARTED 10

2. FUTURES (AND YOUR FUTURE) ............. 15

3. OPTIONS (ON YOUR FUTURE) . 30

4. NATURAL WAVE TRADING THEORY .. 41

5. NEW BEGINNING ...56


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I N T R O D U C T I O N

(1)

Commodities Trading is ancient and dates as far back as thebeginning of human civilization. It was conducted originally as themeans for the exchange of goods among individuals and merchants.The idea was to exchange something of a lesser for something of agreater value. There was an immense degree of subjectivity withthis approach, because valuewas determined upon individuallydesired needs rather than based on any objective criteria.

With the introduction of gold and money the trading process

became more sophisticated and efficient. It was possible to sell andre-sell the same thingover and over. Henceforth, there were peoplemaking a living by knowing what different vendorswere charging forthe same commodity. They were the predecessors of the present-day arbitrageurs and savvy traders who inhabit the skyscrapers ofWall Streettoday.

But it wasnt until the 20thcentury, especially the second half, whentrading became available to anybody who wanted to turn a profit

from the price fluctuation. The idea was old buy low and sell high-but because of the regulated nature of exchanges it gained a newfoundation. The rules were known now and information was availablenot only to the chosen ones but also to an ordinary person, such asyou or me. It became possible for a small investor to compete in theultimate game, wherein fortunes could be instantaneouslygenerated and lost within minutes.

This manuals purpose is to attempt to teach you how to buy lowand sell highand how to apply a more sound risk management

approach to your trading, thus becoming a more successfultrader.

Of course there is no universal method or system (as far as Iknow) that works 100% of the time, and performs flawlessly foreverybody --- yet Im hoping that the Natural Wave Trading Theorywill give an edge that you need in order to stayin the trading gameand walk away a winner. The Natural Wavemanual should help you


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to develop a unique way of thinking, which in return may transformyour frustration with tradinginto a success storyof skilled confidence.

(2)

How do I know that you are frustrated with your progress in tradingcommodities, futures and options, and that youre maybe looking foran ultimate business? Well, you probably wouldnt be reading thisotherwise.

An interesting situation nudged me to write this manual:

I used to be an Account Executive (broker), which means that Iused to place orders with exchanges (in commodities, futures and

option) on behalf of my clients. Doing this over many years has givenme a unique opportunity to observe a variety of trading styles,techniques and methods. Summing up my experience I would saythat the most of the traders lose money and stop trading. After awhile, however, many of them returntotrading in an attempt todiscover what went wrong and why. Also, at that point,psychologically, most are ready to resumetheir trading activities, butseek to locate a system that would teach them how to make moneyWITHOUT losing.

Being in such a state of mind they become an easy prey forpersuasive advertisers and trading system gurus. Understandably,they become willing to spend anywhere between $199 and $299 (oreven several thousand dollars) on courses, tapes, and the like thatsupposedly reveal the secretsof trading. And believe me when I tellyou, that there are no secrets in those courses. I believe betterinformation might be found, in most of the cases, in professionallywritten books by authors like Jack Schwager or John J. Murphy.

Some time ago, through one of my acquaintances, I came acrossa so-called commodities trading course that supposedly teachesyou how to trade. The only telling catch is that the author himself hadonly a smidgen of trading expertise! And to make things even worse

he didnt have a clue what optionswere, and how to trade them. (Inmy professional opinion, options are an alternative trading vehicleabout which every trader should know, either he uses it or not).


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He had simply hand picked the information on tradingcommodities and after packagingit,named it MY Course (I amdeclining to name this particular author, since there is so many otherslike him). Amazingly, he was selling it for about $ 200! I wouldnt besurprised if hes now already picking up tips, from various sources,about options, in preparation to write his My Options Course Well,after all, it is a free country.

(3)

I think I know what you are thinking now (about the Natural WaveTrading Theory manual): Is he cutting the branch hes sitting on?Or to put it differently: What sets the Natural Wave Trading Theory

manual apart from the previously mentioned author who wrote MyCourse?

For one thing, it is offered for free

What is presented in the Natural Wave Trading Theorymanual isan actual working strategy (not a compilation of information on tradingderived from different sources). I lead you by hand, showing thepractical aspect of trading commodities, futures and options.This actual strategy should be also understood as the flexible wayof thinking as a trader. For you dont find here any mathematicalformula that would guarantee you profits (there are no guarantees intrading). What you find here though is the ideaof trading that couldquite possibly become a springboardfor your own actions incommodities trading. Also Im hoping that this idea would bring youcloser to making commodities, futures and options trading your part-timeor full-time occupation a real, viable and potentially profitablebusinessfor you!

Why the title Natural Wave Trading Theory? Ive carefullyconsidered it, and now that its attracted your attention, here is thewisdom behind it. First of all this manual describes a natural andpractical approach to trading. The word theory was chosen toindicate the reference to a set of information that exists out there inthe commodities, futures and options universe, but for one reason oranother is not readily presented before us in an organized fashion.


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The Natural Wave accentuates my belief that just like in surfing,where one has to take advantage of the forces of nature in order tostay above the water, in trading, in order to be successful, one has toevolve along with (and be sensitive to) the forces that shape andinfluence the Markets Reality.

Therefore my purpose is to bring this information to the centerstage and out into the open, so that you might benefit from it. Acertain aspect of this out there information may also be calledcommon sense trading wisdoms, which could be found outsidetechnical indicators, moving averages, oscillators, fundamental andtechnical recommendations etc.

I also believe that you dont have to use a state of the artcomputer technology or so-called trading program to become a

successful trader.


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1. GETTING STARTED

(1)

But lets get started at the beginning. What is the most likelyscenario to occur when you first begin pondering the idea of trading incommodities, futures and options markets? In all likelihood, you aregoing to search theWorld Wide Weband the Internetfor anyinformation that is related to trading.

And in todays business environment it is one of the better ways of

finding out what you need. You dont have to strain yourselfemotionally by talking on the phone to anybody, or drive around thecity visiting different businesses. So, use the computer and the Webas much as possible.

Most of the brokerage houses (IBs Introducing Brokers) offerfree charts and price quotes, directly from their web sites. The quotesare usually ten to thirty minutes delayed, but if you dont trade theSP500, Dow, or Nasdaq Index, it should be more than enough.

There are also some major data providers like Future Source(www.futuresource.com), or Quote.com for example that canprovide you with free comments on different markets in conjunctionwith free quotes and charts.

There is no point in purchasing something, which you can getforfree!

The reason Im even mentioning this is because, yet not so long

ago, there were some brokerages that used to charge as much as$340 a year for the same information that you could get for free ondozens of sites.


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(2)

The next step is to find your own broker or Account Executive (ifyou prefer this expression).You may ask: Do I really need a broker,if I can placeorderson-line,directly withthe exchange? Well, youve got a valid point here.However, let me explain the importance of having your own broker inthe process of trading.

Lets assume that you are placing an order on-line. You press theEnterbutton and nothing happens. Your screen is frozen. Youare trying to Escape, but you are stuck. The perspiration dropletsare forming on your forehead. And to add even more drama to thisburgeoning nightmare, the market in which you are trying to place the

order, is going to closein just five minutesWhat are you going to do?Call 911?No. You are going to call your broker, even though you may not

have very close rapport (and you dont have to) with him/her.

The important thing here is that you have somebody to call whenyou need help. This is why it is so important that you find a brokerand a brokerage house that you feel comfortable with for whateverreason.

Even though you might be trading on-line, you still need abrokerage through which your orders are being placed.

.Of course, if you buy a seat on the exchange for a few hundredthousand dollars, you dont need any brokerage house.

When you have a broker, you may decide that you prefer to placeyour orders through him/her, as opposed to on-line. For if you arenot a very seasoned trader you might be trying to place a bad order

(wrong price, wrong contract month, etc.), and if your broker is anygood he/she can catch it, and by doing so help you to prevent acostly error.

Trying to save ten or twenty dollars on commissions couldpossibly backfire in the long run. So remember that the lowestcommission rate could sometimes mean the poorest results.


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When you choose a broker, it doesnt mean that you have to listento his so-called recommendations. You can simply say that youprefer he keeps his recommendations to himself. Most brokers areprofessionals and will appreciate your directness.

(3)

Okay then, so what is the advantage of choosing a full servicebroker versus a discount broker?

Well, if you really know what you are doing you can go with adiscount broker. You can find places that will charge you only $ 15 to

$ 20 per round turn commission. (Or even $5-10, if you tradeelectronically).

On the other hand, if you are not 100% confident choose a fullservice broker. This way you probably wont get lost in the shuffleand you would get full attention when you need it.

Some years ago there was a big gap between these two types ofservices (full and discount). But in todays trading environment youcan locate many professional full service brokers that will charge youonly $ 30 to $ 50 per round turn commission.

Also you may need somebodyto bounce your trading ideas off of,and in this scenario a full service broker could come very handy. Doyou really think that most of the discount brokers would give you thetime of day?

Im not suggesting you obtain a full service broker so you canhave a friend (although Ive seen this happening as well). Im justproposing that you find your broker, who is somebody with thepossible potential to become a vital part of your team- - - somebodywho can help you and somebody that you feel comfortable with. Youcan also ask your friends if theyve come across a friendly,

knowledgeable and professional broker. Im sure that many of yourfriends and colleagues have dealt with some more or lessinteresting account executives, and probably they would be morethan happy to refer them to you.


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(4)

Next thing you need is risk capital, which is the same as tradingcapital. (The risk capital simply means that you can lose it withoutany financial distress and that your life style will continue as before).

How much do you need to start your trading account? Well, let meask you this: how much do you have?

Your chances of success are greater if you have twenty or thirtythousand US$ as an initial trading stake. The reason for this is soyoull have enough cushions to sustain an adverse price action, andstill remain in the game. On the other hand, if you are very lucky, youcould possibly become a very successful trader while starting onlywith $ 2000.

I do recommend starting the account with whatever you canafford (to lose). Make sure that you dont borrow any money for thispurpose though. You dont really want to have an extra debt stresson your mind. This situation (the need to return the borrowed money)could be compellingyou to trade, makingyou seean opportunitywhere none really exists.

The other end of the spectrum: even if you couldstart youraccount with millions of dollars, start with only $100,000 (even if youwere a so-called experienced trader in the stock market, forexample). It is very easy to get carried away by your own or yourbrokers imagination. You may end-up taking too many positions evenfor your account size (over-leveraging), which could have quite tragicresults for you.

There is nothing wrong with adding more money to your accountlater on, when youre thinking straight and with a cool head. After atest drive, you can take the plunge with more capital, when you feelmore comfortable with your initial progress.

But no matter how much money you initiate your account with,remember at least one thing (even if you forget all others) that thismoney must be only risk capital (money that you can afford to lose which does not mean that you want to or have to lose). You dontwant any loss to affect your life style or cause you any unduefinancial distress.


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Also from the psychological point of view, if you trade with moneythat you cannot afford to lose, you are destined to do a lot of benchsitting, while genuine trading opportunities are passing you by


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2. FUTURES (AND YOUR FUTURE)

If you have been trading commodities, futures and options for awhile, chances are that youve heard some stories about the

incredible fortunes that were made. For example, somebody startsan account with $ 5,000 and turnsit into $ 30,000 or $ 250,000 intwelve months or less. It is achievable (not easily sometimes)because of the leverage that exists in futures and options markets.

The terms Commodities and futures are going to be usedinterchangeably throughout this manual - although some tradersassign commodities to the contracts that represent tangiblegoods (corn, soybean, sugar, gold, copper), and futuresmostly to financial markets.

It is also true that the same leverage that could potentially leadyou to significant returns could also become the source of yournightmares. A lot of fortunes have been lost because of this kind ofleverage. In other words, as a trader you constantly walk the thin linebetween riskand reward.

If you are an experienced trader you can skip this and nextchapter and go to the heart of the Natural Wave Trading

Theory. On a second thought, you could come along for a ride.Maybe you could learn something new

So, whats a big deal about the leverage anyway? Well, lets takea closer look.

Im going to use mostly a corn contract, throughout this manual,for exemplification purpose. However, as well find out later, thecorn market seems to be an ideal trading ground for theNATURAL WAVE TT. But lets dont get ahead of ourselves toomuch

All exchange traded commodities and options have definedcontracts specs, like size, point value, minimum tic, limit move, etc.

Some of the contracts trade in points (like sugar: if October Sugarmoves from 657 to 667, it is a 10 points move. And because 1


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point=$ 11.20, the 10 points move in sugar equates to $ 112 percontract).

Some contracts trade in cents (like corn:a move from 211 to 212equals only 1 cent. And 1 cent in Corn is valued at $ 50. Therefore ifyou bought 1 contract of Corn at 211 and got out at 212, you wouldhave made $ 50 profit. The minimum price move in Corn futuresmarketis - quarter of a cent, which = $ 12.50).

You can find the details about those specs with any exchange orbrokerage house. It is free.

So how does the leverage fit into all of this?

Again, the best way to demonstrate it will be with an example.Lets take a price of Corn at 211. What it means is that if you were to

buy 5,000 bushels (the equivalent of one contract of Corn in theexchange traded futures/commodities) of Corn in the open marketyou would have to pay $ 10,550 cash.

$ 2.11---price of corn per bushel

X5,000---bushels

_____________________________________

= $ 10,550 ---total amount paid for 5,000 bushels ofCorn

Other words, if you expected that corn prices will go up, and ifcommodities exchanges didnt exist, you would have to come up with$ 10,550 in Cash (!) in order to purchase 5,000 bushels of Corn (andif you of course had the room to store it). Theoretically speaking youcould hold on to it forever. And even if Corn price declined to ZERO,you could wait for as long (providing that the corn is not going to

spoil) as necessary for the prices to recover, and go up again to 211or beyond. Just remember though that through the whole waitingperiod you would be tying up the entire $ 10,550, and you wouldworry if Corn can be preserved in good enough conditions for thefuture resell to somebody else. And of course later on you wouldhave to convince the buyerto buy from you the old crop as opposed


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to the new crop that is readily available (most likely) from anotherseller.

Lets continue our Corn Storywith an assumption that Corn priceseventually recovered afterlets say 1 year later, and went to 241.At that point youve decided that it was time to get rid of your Corn,and you were lucky enough to sell the whole 5,000 bushels at 241

So a quick calculation, and you realize that you made $ 1,500profit [$ 2.41- $ 2.11 = $ 0.30, times 5,000 bushels = $ 1,500].

It took you$ 10,550to make$ 1,500 profit.

Not bad, you say. I say: it is only 14 % return, for this muchheadache for the whole year (!).

At the same time if you were trading on the exchange (CBOT-Chicago Board Of Trade), and went long (bought) only one contractof Corn at 211, and sold it (got out) at 241 you would have made also$ 1,500 profit. But in this case it would be 122 %return on yourmoney.

Am I trying to trick you?

No, Im not. In order for you to trade on the Exchange one contract(5,000 bushels) of Corn you need only $ 675 an initial margin (thisamount could vary, pending CBOTs decision, but over the years itremained within a few hundred dollars range). This $ 675 is nothingmore than a good faith deposit, which means that if you makemoney on your trade, this $ 675 will return back to you on top of theprofit you had made.

If market went from 211 to 241 and you got out of yourlong position -you were riding the marketyou would bepaid $ 1,500 profit. Your original $ 675 deposit is called: Initial Margin

So using only $ 675 (oppose to $ 10,550) you made also $ 1,500profit. Isnt this amazing?

Try to imagine than how much Corn you could control with $10,550:


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$ 10,550 divided by $ 675=15.63 (contracts)

It is hard to believe, but with $10,550 you would be able to buy 15contracts of Corn (on the exchange), and by doing so you will be in acontrol of 75,000 bushels of Corn. Thats the power of leverage.

At this point, if you went long (bought) at 211 on your 15 contracts,and exited your position at 241, you would have made $ 22,500{241-211=30, times $ 50 (point value in Corn)= $ 1,500, times 15contracts=$ 22,500}.

So what would you rather do with $ 10,550, control only 5,000bushels and made $ 1,500, or control 75,000 bushels (15contracts) and made $ 22,500?

PLEASE, REMEMBER THAT LEVERAGE WORKS BOTH WAYS.AND IN THE REAL WORLD OF TRADING YOU COULD ALSOLOSE YOUR MONEY JUST AS QUICKLY AS YOU MADE IT.

If understanding leverage were enough to make money in tradingcommodities, futures and options, then we would be walking among agreater number of millionaires. But this obviously isnt the case. Theleveraging concept is therefore a double-edged sword. When you

trade on margin(as you do with exchanges) your risk could be asgreat as your profit potential.

(The Natural Wave TT that will be covered in the 4thChapter of this manual demonstrates to you howto keep your risk under control, while potentially having anunlimited profit potential.)

This is mainly why the tradingis so challenging, and why so manytraders are out of the game before theyve even had a decent

chance to develop their own trading plan.Lets use an example to illustrate the challengingnature of the

futures contracts.


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Example:

Lets assume that you opened your trading accountwith $ 5,000.You are looking at the Corn Daily Chartthat looks something like this:

(Im not going to spend much time here to analyze the chart

formations. Later on, it will become more apparent: why (?). If you arehungry for more information on the commodities markets, pleaserefer to a classic by John J. Murphy: The Technical Analysis of theFutures Markets. It is well written and could be understood even bythe novice trader, and it gives very comprehensive overview ofdifferent chart formations.)

You are expecting that Corn prices will go up. They do go up andyou:

1. Buy 3 contracts of Corn at the market.2. Your fill price is 224.3. Your Initial Margin (the amount of money used out of your

account as a good faith deposit) is $ 675 x 3 contracts=$2025.

4. So how much money do you have left for trading?


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5. $ 2,975 (?)6. Not quite. You have to subtract the commission cost. If your

Round Turn commission is $ 50, you will be paying a half of it($ 25) to initiate this trade- $ 25 x 3 (contracts)=$ 75.

7. So you have left not $ 2,975 but $ 2,900. (Dontconfuse this amount with your account balance, which would beabout $ 4,925).

8. Next day Corn market goes to 234, but you decide to remain inyour position overnight. What would be your account balance aftermarket closed at 234?

Lets calculate this together:a) you made a profit of $ 1,500 (10 cents per contract times3

contracts, times$ 50-cent value in Corn),b) your initial balance was $ 4,925 (after paying half of the

commissions),c) so your second day accounts balance would be $6,425 ($

4,925+$ 1,500).

So now you have more money available for trading. Right?$ 6,425

- $ 2,025 (Initial Margin)_______________________________

=$ 4,400

This $ 4,400 is called Margin Excess. It is all the money on youraccount that is not tied up for the Initial Margin Requirement.(Theoretically speaking, you could use all this money for tradingadditional contracts, but from the practical point of view it isntrecommended. Its a great idea to have a cushion on your account.So if markets move adversely against you, you have some money onthe sidelines to absorb the blow. As an idea for you try to keep

roughly 50% of the money on your account in form of cash, if youtrade future contracts)

So now you tell all your friends how much money you are making,and how easyit is to trade commodities


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But what you are forgetting is that you are still in the market andyou still holding on to your original position, and that money is notyours until your close your position.

But I have astop loss@ 229 protecting my profits. If marketdeclines to 229, from 234, Ill be out of my Corn position you say.SowhenIm stopped out @ 229 I would end up making $ 750profit.

Well the keyword in your last statement is when. It should berather if. Because what could very well happen is that for the nextthree trading sessions the Corn market goes down limit, andremains locked down limit.

Limit move means that the market cannot move more than thespecified distance. In Corn this distance is -lets say- $ 600 or 12cents (unless exchange changed that amount to 20 or 30 cents, dueto increased Corn market volatility). In some other markets this limitwill be different. Yet some other markets dont have any limit.

So from 234, Corn goes down (through your stop loss @ 229):

---First Dayto222.---Second Dayto 210.---Third Dayto..198.

During those three trading sessions you were not able to exit yourposition, because there was no active trading going on in the CornPit.

Try to imagine how damaging to your emotional state this situationis. You cant sleep well. When at work, you keep thinking about yourCorn position rather than about doing your job. When at home you

are short with your wife your kids, and you are mean to your dogand your neighbor. There is a dark cloud hanging over your head.Even though $ 5,000 was your risk capital (money you could afford tolose), yet you thought you could use this money for a familyvacation

And suddenly you turn religious, and start praying. You know thatif Corn goes down limit for one more day your account will go


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negative or upside down (you lose more than you started youraccount with).

Luckily for you, your prayersare answered, and on the Forth Daythe Corn market opens @ 196.

Your stop loss of 229 is triggered then, and it becomes a marketorder. You are stopped out @ 196.

What is your account balance now?

234-196=38,38 x 3 (contracts)=114,114 x $ 50 (point value in Corn)= $ 5,700.

When Corn was @ 234, your account balance was $ 6,425. And afew days later when you got out of the market, you balance is:

$ 6,425 - $ 5,700 = $ 725,$ 725 - $ 75 (half a turn commission times 3 contracts) =$ 650.

The final balance on your trading account would be 650 $.

REMEMBER: THERE IS NOTHING WORSE IN TRADING THANSEEING THE MARKET MOVING AGAINST YOU AND NOT BEINGABLE TO DO ANYTHING ABOUT IT, EVEN IF YOU WANTED TO.

Chances are that after this roller coaster ride in the Corn market,you will call your broker and close your account.

What is themoralofthis story?

Dont praise the day before the sunset, or putting it differently, dont

spend your money, while still in the trade.

Of course the above example of the Corn trade is somewhatsimplified. Nevertheless, generally speaking, it captures theups and downs of an average trading account incommodities. Also, due to increased volatility of the grain markets,in the recent years, the limit moves were adjusted up, so the limit


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move in Corn could quite well be 20 or 30 cents. Before trading,make sure to obtain up-to-date specs on the contract and marketsyou are intending to trade.

My intention here is not to discourage you but rather toinvite you to search for a better way of trading. And I do hopethat this very manual will help you in this process.

ITS TIME NOW FOR SOME GENERALREFLECTIONS ABOUT THE FUTURES MARKET:

This manuals purpose is to demonstrate to you a unique way oflooking at the reality of trading. Under no circumstances it should betreated as an encyclopedic source of information about the technicalchart formations or fundamental gossip. There are more thanenough books, trading programs and courses that discuss thosematters. Im sure that you wouldnt have any problems with findingthe right ones for you.

Throughout this manual, Im going to keep my reference to the

technical chart formations only to the very minimum. For I do believethat, if you look at the market from the historical point of view (whereprices of this market are recorded in the graph format), and see thatthe market is trading in the level of ten or twenty-year lows or highs,statistically speaking, your odds of predicting correctly the direction ofthe market -over the next few months- are greater. On the otherhand, if you are looking at the chart that covers only three to sixmonths price data, and you are trying to predict the direction of themarket for the next few months (without referring to ten or twenty year

chart) your chances of being correct are lesser.

Knowing this is worth money. For if you are going to treat tradingas business, you need to take advantage of everything that couldincrease your odds of success.

*


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Of course when you trade markets like SP500 or NASDAQ -whichwere offered as the trading vehicle only in recent decades- and aregetting inand outquickly, you dont really care as much about thetwenty or thirty year chart.

In here though, Im focusing more on markets that have longtradition and history of trading (grains, gold, silver, meats, softs,coffee). There, in multi-year graphs, you can see how the humanmind works. If something is at ten-year lows and the distance fromthere to all time lows is not far, chances are that it would be a goodtime right now to start establishing your long position.

However, even though you could be right on the direction of themarket, you may run out of money or time before the market takesoff. And this is another reason why so many traders lose in trading.

This is where the Natural Wave Trading Theory willcome handy.

In the Introduction I referred to the principle of trading: buylow, sell high. The reason for it is my belief that in todays tradingenvironment we tend to forget this basic principle.

What we see instead in front of us is the number of differentoscillators, moving averages, buy and sell signals, etc. We simplyforget that many of the trading systemsare just the hypotheticalmodels, constructed on the selected market data. And since marketsevolve in terms ofvolume (number of contracts traded daily),sophistication of participants, volatility (how fast and how muchmarkets move in a certain period of time), many systems or tradingmodels that were valid not so long ago- are no longer compatiblewith live markets.

Thats why there is a need for a unique way of thinking aboutmarkets and trading them, the need that is rooted in this traditionalbuy low, sell high principle. This will force us in a way, to bepatient, and to trade only markets that are either multi-year low or

high. The idea is not to just trade for fun, but to trade for fun andmoney.

In Chapter 4, Im going to demonstrate the style of tradingthatcould not only save you money, but also insure that you remain in themarket, even when it moves against you. This way you can wait andadjust your position accordingly.


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As a trader, you should learn how to be flexible, how to adaptyourself to ever changing market conditions. Yet with change dontforget what is constant: markets go up and down and they areattracted to price equilibrium. Just think about the expressions thatwe hear or use every day: extreme low, extreme high, flatmarket, extreme volatility, etc. Those expressions are possible,because we refer to some information in usor in historical data(orboth) that is objective or typical. Just think about it---if we didntperceive the usual conditions of the market, we wouldnt be able tonotice what is unusual, extreme, or strange.

And knowing this is worth money: If Corn, for example, is tradingat the extremely low level (ten-year low), the chances are thatsooner or later, it is going to move up. And not even oscillators ormoving averages are going to change it.

However, keep in mind that knowing is one thing and doing isanother. You probably have heard somebody saying:

I knew that this market was going to move UP. Andlook what it happened it really did.

YOU: Okay, so how much money have you made?

Somebody: Actually I didnt. I didnt have enough moneyto trade this market.

Or:

Somebody: Actually I was right, but was stopped out(2) and then the market moved in the direction

I thought it would

REMEMBER: You may be right on the direction of the market,

yet end up losing money.

The NATURAL WAVE TRADING THEORY is designed in suchway that using its ideas you might be able to stay afloat (even whilethe market is moving against you) and not being stopped out.


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The Natural Wave Trading Theorys purpose is to limit your initialmargin requirement, sometimes as much as to ZERO (Thats right,you read me correctly).

So even if you are afraid of losing your initial stake, the NaturalWave TT could give you more confidence and staying power, anddramatically reduce your risk exposure.

I will address this more in the following chapters. But before we gothere, I want to make sure that you have a good grasp of thefollowing concepts:

Initial Margin Maintenance Margin Margin Call (!)

And as a bonus [ ]- Im going to include the concept of sellingshort- How can I sell something I dont own?

Initial Margin. It is the good faith deposit placed with anexchange. It is withheld from your account with a brokerage house. Itallows you to participare in trading in a particular market.

An exchange decides how much of an initial margin is needed totrade in a particular contract. The criteria of risk is being used todecide on the amount of money that is needed to control one futures

contract in a particular market.For example, the initial marginon Corn is lesser than on DowJones (about $675 and $6,000 respectivelly as of 2000), becausethe Corn is less risky than Dow.

Generally speaking, initial margins dont change that much,although they could go up and down quite significantly if the volatilityin a particular market changes. And if you are already in the marketyou are also a subject to the new margin requirement.

The initial margin is per contract basis. So if you want to trade 5contracts of Corn, you need $ 675 x 5= $ 3,375.

Maintenance Margin. I call it the policeman on your account.Lets assume that your account size is $ 1,000, and lets forget fornow about the commissions. Also, lets say that the exchange hadestablished $ 400 maintenance margin on Corn.

So because of the initial margin on Corn ($ 675) you can trade 1contract of Corn with your $ 1,000 account.


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However, if the future market moved 11 cents against you (11 x $50=$ 550) your account balance would be $ 450 ($ 1,000-$ 550).Even though the balance of your account is below the initial marginrequirement ($ 675), theoretically you are still okay. You could remainas you are with doing nothing. However, if Corn moved 1 more cent($ 50) against you, your account balance would be at $ 400. Youraccount will be at the level of the maintenance margin. At this pointthe accounts policeman would blow his whistle. The MaintenanceMargin will be reached, and you will be on the

Margin Call (!) And if you wanted to maintain your position as it is,you would need to deposit to your account the difference between thecurrent accountbalanceand the initial margin requirement- $ 275(675-$ 400).

When you are on the margin call, you have to bring you accountbalance back into black, which is at or above the initial marginrequirement. If you fail to do so (as soon as possible, usually 24hours), you would have to close your position.

The ideas of marginand margin callare an important background ofthe Natural Wave Trading Theory. It is why I had spent some time on

them. This will become more apparent in Chapter 4.

However, before we shift to the next chapter, I would like to try to

explain one more concept that seems to keep many of the newtraders awake at night:

How can I sell something that I dont own?

As you already know, this concept has to do with shorting themarket (selling, or going short). It has to do with establishing ashort positionin anticipation of price decline.

In this case what you are simply doing is reversing: buy low, sell

high. You are selling highand trying to buy back lower.Okayokaybut how can you sell something you dont own?Well, do you think that you really own something when you are

going long in the market (?). Think again. When you are buying lowand expecting to sell it higher later on, do you really think that youare the owner of the contract? No, you are not. If you were, you


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wouldnt be on a margin call in the first place, or wouldnt be forcedout of your position.

When you are establishing your initial position in the market bybuying, you simply taking control of the contract at the specific price.Other words, with your initial margin (good faith deposit) you areborrowing the contract at the specific price. You are hoping that pricewill rise, and that you will be able to return (sell) this contract to theexchange later, and pocket the difference.

By the same token, if you noticed that a commodity is very high,and expecting for it to decline, you may want to take advantage ofthis scenario by selling at that higher price and bying back later at thelower price (to offset your original short). In this case your initial

transaction would be selling. You are borrowing a contract from theexchange with the promise (insured by your good faith deposit) ofreturning it later.

So if you sold 1 contract of Corn @ 234, and bought it back later@ 214, you would have made $ 1,000 (234-214=20, 20 x $ 50).

Lets illustrate this selling something you dont own with yetanother example:

Your collegue at work is getting married and he is looking for onecarat diamond ring.

A friend of yours is a jeweler. You go to him and he lets youborrow a diamond ring, which you think your colleague at work couldbe interested in. ( To add an extra twist to the story, lets say that youhave to return this or identical ring to your jeweler friend within twoweeks).

Surely enough you colleague at work gives you $ 5,000 for thering. You put $ 5,000 cash in your own pocket andYou start looking

around to buy the identical ring for less than $ 5,000. And you have toby the identical ring because you promissed your jeweler friend thatyou would return the ring not later than in two weeks.

One week later you are able to buy an identical ring that youvesold to your colleague at work for $ 4,200; and you use Cash ($5,000) from your pocket to pay for it.


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How much money have you made in the process?$ 800. ($5,000 minus $ 4,200).

You made this profit by selling something that you didnt own (!).

On this note, we are ready to wrap up this chapter and move on tothe next.


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3. OPTIONS (ON YOUR FUTURE)

Maybe youre one of those people who are simply paralyzed bythe uncertainty of the trades outcome. Even if the market is movingin your favor you are so self-conscious of the built-in risk factor ofyour position that you are afraid to remain in it any longer. You makean irrational decisionof getting out, and the market keeps on going inthe same direction for what it seems like forever.

And no matter how brilliant and eloquent you are in justifying yourdecision of getting out, the bottom line is still the same: somewherein the dark corners of your mind a doubt is lurking that you left abunch of money on the table.

To simplify the above situation I would say that the fear of risk the uncertainty about the amount of capital you could lose on a trade

could reduce dramatically your potential as a trader.

It is why the options on futures seem to be an ideal tradingvehicle for traders who cant handle or cant afford excessive risk.

What is an option?

It is the right but not the obligation to be long or short in thefuture market from the specific price within certain period oftime.

(When you trade options youre trading those rights, not the futuremarket.)

But what it really means?

It means that you have to pay a premium if you want to purchasethis right. And the amount of premium varies, depending on thenumber of factors:

1. How close to the current price of the future market your optionis.

2. How much time to expiration your option has.3. How volatile the underlying future market is.


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Lets use an Example:

Consider December Corn:

(Its called December because it expiressometime in December. At this point you couldswitch roll over- to the next available Corncontract, which in case of Corn would be March.The average contract life in non-financial marketsis 9-12 months.)

Lets say December Corn is trading at 221. You are expecting thatDec. Corn is going to move up to 260 by the end of November. And

since it is only July now you have about 4 months before DecemberCorn options expire.

(Usually options in non-financial markets expire2-3 weeks before their underlying future contract.But check with your broker or a trading advisorfor more detailed information.)

If you expect the price to go UP you want to buy a CALL option.If you think that prices will go DOWN you want to buy a PUT

option.

The Calls and Puts have pre-established (by the exchanges)strike prices. And the strike prices mark-in the identical intervals-different levels of futures prices. So in the case of Corn market, strikeprices are established in the increments of 10 cents. It means thatyou could buy:

250 Call

240 Call230 Call220 Call210 Call etc.

By the same token you could buy some Put options if you wereexpecting that prices would move down:


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220 Put210 Put200 Put190 Put180 Put etc.

And each of these strike prices has a different value (premium/price).

Generally speaking, the premium/valueof an option is based onthe following factors:

Intrinsic value. Time to expiration.

Volatility.

The intrinsic value: If the December Corn future contract istraded at 221, and you have 220 Call option, this option is 1 cent inthe money or has 1 cent of the intrinsic value.

And the value of such an option will be greater than one that isfarther away from the current future price. If your 220 Call werecosting you for example $ 600 sometime in July, a 250 Call wouldcost you probably somewhere around $ 200. The reason for this isyouhave a greater chance of making a profit on 220 Call than youhave on 250 Call.

Time to expiration means when does your option expire.Obviously the more time to expiration there is on your option, morevaluable this option is going to be.

Volatility of the option is absorbed from the future market,which underlines a particular option. The SP500 market is by farmore volatile than Corn market. This is why SP500 at the money

option can cost as much as $10,000 or more, while at the moneyoption in Corn runs usually a few hundred dollars

What exactly is meant by the term at the money anyway?Well here lies the gist of it:


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An option isat the moneywhen its strike price is at thelevel of current price of the underlying future contract. IfCorn future is trading @ 220, 220 Calloption would beconsidered at the money.

An option isin the moneywhen an underlying futurecontract is above (in case of a Call) or below (in case of aPut) the strike price. For example, if you have Corn220Calloption and the future market is trading at 227, this220 Call is in the money.

An option isout of the moneywhen it is not touched bythe future contract. If Corn future is traded at 211, 220Callwould be considered out of the money.

REMEMBER that more time to expiration your option has, andcloser to the current price of the underlying future market it is,and more volatile the underlying future market is, moreexpensive (and more valuable) this option is going to be.

Options provide you with great leverage. If the future marketmoves significantly in your favor, and your option becomes deep-in-

the-money, you have a chance of making almost as much moneywith your option as you would have with a future contract.

On the other hand, options give you great comfort in case of thefuture market moving dramatically in the other direction than youexpected. In those moments youre very glad that your total risk onthe trade was the premium cost and commission paid for such option.

WHEN YOU ARE AN OPTION BUYER, YOUR TOTAL RISK ONA TRADE IS THE PREMIUM AND COMMISSION THAT YOU

PAY FOR IT, PROVIDING THAT YOU LIQUIDATE YOUROPTION PRIOR TO ITS EXPIRATION.

To illustrate the difference between the future and option trade,lets assume that you bought 1 December Corn contract at 220, andthat you didnt place any protective stop loss. And lets just say, for


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the sake of example, that Corn declined 60 cents ($ 3,000 on 1contract=60 x $ 50). So you lost $ 3,000 on just 1 contract.

At the same time infamous John Doe bought 220 Call option inDecember Corn, for which he spent about 12 cents or $ 600.

In reality you lost $ 3,000, while John Doe only $600. And thebest part for John is that he still owns his option until the expirationdate. So if December Corn went eventually UP (after such a bigdecline) not that only he had a chance of recovering some of theoptions premium, but maybe even making a profit, if the underlyingfuture contract exploded UP and went way above 220 level.

As for you, possibly you ran out of money and had to exit yourfuture trade

Next question that practically jumps at us here is:

Can I make any money on the option if the future market neverexceeds my strike price? (Can I make any money on an option if itnever becomes significantly in-the-money?)

Yes, you can. Just remember that the money is not yours yet, ifyou didnt liquidate your option. Your option is a wasted asset (likethe new car you just bought). It means that even if the option, whichyou bought for $600, becomes worth $ 3,500, you cant use its profitfor any other trade, until you offset (exit) it.

(IN A FUTURE MARKET YOUR PROFIT IS REALIZEDINSTANTLY --SO-CALLED MARKET-TO-MARKETSCENARIO. YOU CAN USE THIS PROFIT RIGHT AWAY,WHILE YOU STILL IN THE ORIGINAL POSITION THAT MADEYOU THIS PROFIT.)

Buying an option as an initial transaction is not the only thing

that you could do with an option. Another one, for example, isselling an option as an initial transaction. In this case you wantfor your option to lose value. If it expires worthless, than you willbe able to keep the money youve collected originally, by sellingit.

The major problem, however, withselling an optionas aninitial transaction is that there is only limited profit that you can


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make value of the premium at the time of sell. Worse still isthat should the future market dramatically move against you,youll virtually have an unlimited risk.

This is why, in the case of the Natural Wave Trading Theory,were mainly interested in options, which are bought in the initialtransaction. We want to havelimited riskwithunlimited profitpotential.

Other words, if you bought 250 Call in December Corn at 8 cents(8 x $50), and it went to 70 cents in value, after significant rally in thefuture market, if you sell this option at this point, you will be putting $3,500 back to your account (70 x $ 50). But since you paid for it $ 400in premium, and $ 50 in commission, your net profit on this tradewould be:

3,500- 400- 50

=3,050 ($)

Although not impossible or unusual, in the case wherein you makea few hundred percent return on your money, this doesnt happenvery often.

Most likely whats going to happen, more often than not, in yourtrading career is this:

You purchased 250 Call option in Dec. Corn, when the futuremarket was at 219. You paid for the option 8 cents or $ 400. Over a

period of two months prices on Corn went up to 247 (notice that theprices dont reach your strike price yet). And now because the futuremarket is so close to your strike price, the value of your option couldbe then around 13 cents, or $ 650.

At this point you could liquidate your option, and put $650 back toyour account. And your profit then would be $ 200.


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650-400 (premium you paid)-50 (commission)

=200 ($)

As you see in the latest example, youre not making as muchmoney on this option as you would have had you been in the futuretrade:

If you bought 1 December Corn future contract at 219, and got outat 247, your profit would have been $ 1,400 (28 x $ 50) - $ 50(comm.)= $ 1,350.

But even though youve made only $ 200 profit (oppose to $1,350), you had known your risk exposure whole time. You chosesafetyand there is nothing wrong with that.

*

We spoke much about an options liquidation, but we didntmention exercise. What is the difference between liquidation andexercise?

Generally speaking, you could liquidate all options as long as theyhave any value. However, you can exercise only those options, whichare in the money. (Actually you could exercise any option, even onethat is out of the money, but it wouldnt make any sense, for youwould be losing money on this procedure).

Example:

You bought 250 Call in December Corn a couple of weeks ago,when future market traded at 219. Lets assume that Corn future istrading today at 300.

At this point, if you exercise your right (option) to your 250 Call,you will be long one Corn contract from 250, even though the futurecontract is trading at 300. You will be required to put up the margin(about $675, or more, which depends on the current margin


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requirements); which in this case wouldnt be a problem since thedistance between 250 and 300 is 50 cents or $ 2,500 (50 x $50).

So through exercise you are gaining access to the cash that wasfrozen in your option, and you can start using it immediately foreither purchasing additional options or future contracts, or simply toadd some of it to your checking account.

The downside to this scenario is that if future market goes sharplydown, you could be stopped out (if you placed the stop and marketisnt locked limit down), losing more money than you feltcomfortable losingetc.

Also when you exercise an option you are giving up the originalpremium for which you paid so dearly. This is a very important issue

when it comes down to exercising options that have a lot of time toexpiration. For if you have 250 Call in March Corn, and it does notexpire for six months, it wouldnt make any sense for you to exercisethis option if the future market for March was trading at 255. Chancesare that your option would be worth around 20 cents or $ 1,000. Andif you had exercised it at this moment you would be gaining only 5cents or $ 250 (255-250=5, 5 x $ 50), and your entire $ 1,000 value(which contains also your originally purchased premium) wouldvanish, leaving you only with $ 250. So it would be better for you toliquidate this option in this case.

SO, WHATS BETTER: EXERCISE OR LIQUIDATION?

Well, it depends

Generally speaking, most options on the retail (non-commercial)levels are liquidated. However, there are some unique marketsituations in which exercise might make more sense. Please, checkwith you broker or trading advisor regarding this issue.

(If December Corn future contract went up to 300, andyou had 250 Call option, this option could be worth 55cents or $ 2,750 it depends on volatility of the marketand time to expiration. This option would be obviouslycomposed mostly out of intrinsic value 50 cents.However, if it still had some significant amount of time left


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before the expiration, this significant time to expirationcould possibly add an extra value to it. In such caseliquidationwould make more sense).

Keep in mind though that the reality of trading is much richer thanany theoretical analysis or description of it. This is why you shouldlearn how to be flexible in your trading. Oftentimes market conditionsand circumstances could appear identical to what youve alreadyexperienced or read about. But remember that every market situationis unique in its own way (even if it appears as something that youalready know), and it can surprise you at any moment.

It is important that you stay attuned to the markets (watch pricesdaily, read any pertaining information, yet keep your own opinion),

which you trade. Also you should feel comfortable with methods thatyou trade these markets with.

When as a trader you have a peace of mind and youve taken careofrisk exposure on your positions, you are more inclined to noticecertain new ways, in which you could possibly trade. And this is a partof this flexibility that Im talking about

I know, I know, youre probably waiting to see an example of suchflexibility Well, the entire next chapter is dedicated to it.

However, before we go there, I would like to give you an examplethat would illustrate an advantage of usingan option(in thisparticular case at least) versus future contract.

Example:

Lets say that youre expecting Corn to go UP. You are buying 1December Corn contract at 219.

John Doe is expecting the same, but he is buying 2 December 250

Call options instead, for 6 cents each.

On your trade you are tying up $ 675 (or more if the officialexchange established requirement is higher) for the initial margin,plus you have virtually unlimited risk (actually in this case your riskis $10,950, if Corn went down to ZERO), if Corn went down limit formany days.


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John Doe is spending: 2 x 6=12, 12 x $ 50= $ 600,+ 2 x $ 50 (commission)= $100. So the total is $ 700. And this is totalrisk he is taking, as long as he is going to liquidate his options prior toexpiration or let them expire worthless.

And 6 weeks later December Corn is trading at 350. You and JohnDoe decide to exit your respective positions. Who is going to makemore money?

You would be making: 350-219=131131 x $50 (point value)=$ 6,550

$ 6,550 - $ 50 (commission)= $ 6,500 (net profit).

John Doe would be making: 350 250=100

100 x 2 (options)=200200 x $ 50 (point value)== $ 10,000.

$ 10,000 - $ 700 (cost on 2 options)= $ 9,300 (net profit).

So, in the above case John Doe made $ 2,800 more than you did,and his risk was limited. (Of course the situation would be different ifCorn went UP only to 255 when you and John decided to close yourpositionsbut thatsthe different story).

Why would anybody want to trade futures then?

For the following reasons: (1) having the profit money availableinstantaneously for additional trades,(2) in most cases better liquidity than in options, and

Although you and John expect that prices will move very high, it

isnt guaranteed. And what could have very well happened is thatDecember Corn didnt go beyond the 240 price level, before theoptions expiration. At this point 250 Calls would be worth ZERO.

And if John got out of his long Corn position in future contract, atthe same time that your options expired, he wouldve made profit of $1,000.


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AS I SAID BEFORE, IT IS VITAL THAT AS A TRADER YOU AREFLEXIBLE IN YOUR TRADING. OR PUTTING THIS RATHERDIFFERENTLY, YOU HAVE TO EVOLVE ALONG WITH EVERCHANGING MARKET CONDITIONS.

The next chapter is dedicated to the flexible way of thinkingabout the markets. Well be trying to outline a special paradigm oftrading, in which youre probably more concerned with managing yourrisk exposure, than with profits themselves. Ultimately, the winningpartwill take care of itself, and having learned how to control yourrisk well, you probably will have easier task of managing your profits(and your every day life).


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4. NATURAL WAVE TRADING THEORY

In previous chapters I tried to outline some ideas on tradingcommodities, futures and options markets. It was only an outline,focused mainly on simple trading strategies that purposefully illustratea basic nature of the market movements, and the basic ways in whicha trader wants to take advantage of those movements. It was only anoutline, but hopefully it was informative enough, so even if youre abrand new trader you couldve gained initial knowledge as astepping-stone on the road to the development of your own style oftrading.

I didnt discuss different chart formations or fundamental analysisbecause there is number of well-written books covering those areas,

and there was no point of duplicating something that is alreadyplentiful. The books by John Murphy i.e. The Technical Analysis ofthe Futures Markets or some by Jack Schwager, are the greatsource of market knowledge and inspiration.

Youll find also plenty of courses on trading commodities. Inmany cases they are well crafted. Some of the courses are betterthan others, and I believe that you could learn somethingfrom everysingle one of them.

The Natural Waveis not a summary of information about themarkets that you could find easily in various sources. It is rather aninvitation(an initiative) to creative and flexible thinking about the wayyou could trade.

I believe that if you treat trading in futures and options as abusiness, you have the chance of achieving not only good profitsbut also personal satisfaction.

Over the years Ive realized that one of the major reasons whytraders (most of them at least) lose are:

Poor risk management. Lack of patience. Fear of losing, fear of being wrong. Lack of a trading method.


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Although these are not the only reasons, I believe that theyremost significant. Looking closely at all of them, we realize that theyare different aspects of the same thing the trading experience. Werealize that they all are connected, and that one is affecting another.

So if you can implement good risk management strategies,chances are that the fear of losing would dissipate. By the sametoken youll become more patient, because your unique method oftrading (of which risk management is part) would prompt you to waitfor the right market conditions, in which the odds of a profitable tradeare greater.

On the other hand the good risk management is the result ofapplying sound (the one you feel comfortable with) method to yourtrading, a method which gives you confidence. This confidence is

born out of your ability to control your trading environment, yourability to control your risk exposure.

At this point you have no fear (hopefully) of losing. And chancesare that the trading decisions you are going to make will be moreaccurate, for theyre not going to be soiled by the negative thinkingand emotions.

MAKING MONEY IS DEFINITELY THE REASON WHY YOU AREIN THIS FUTURES GAME. This is why it is so important that youbelieve in yourself; believe that you can (and will) make money intrading. If you dont have a right frame of mind, dont even bother; youwould be only wasting your time.

When you implement trading the right way (it doesnt mean it isthe only way) youll find yourself facing more free time on your handsthan you know what to do with. You will have more space to dothings that you only dreamed of. Youll have more time to focus onthe important things in life.

So what is this right way of trading?

I call it the NATURAL WAVE TRADING THEORY.


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1

In preceding chapters weve discussed the fact that if you justtrade futures contracts, theoretically you are facing an unlimitedrisk. Putting it differently, the amount of money you have at risk is notwell defined (even with a stop loss).

When you just buy options on futures, your risk exposure islimited, with virtually unlimited profit potential. But oftentimes thefutures markets dont move enough in your favor to realize profit onyour option. As a consequence, your option expires worthless.

(There are different strategies in options, which involve sellingan option or granting it, as an initial transaction. In most ofthose strategies you benefit when futures markets never come

even close to the strike price of your options time decay workshere in your favor. You could learn more about this type oftrading from many books on options trading that you can find inyour local or on line bookseller.)

So naturally the following question comes to mind:

Is it possible to forge futures and options into one trading stylethat would combine best features of both worlds?

The answeris: Yes.

You could use futures and options together in the variety of ways.The Natural Wave TT is exploring some of those ways.

The Natural Wave Trading Theory isnt a trading systemthough. It is rather a paradigm of thinking, a paradigm in whichflexibility plays an important part.

We believe that if you develop your own stylehow to think like a

trader where controlling your risk exposure is one of your primaryobjectives- youll be able to enjoy all those perks that come withsuccess:

Peace of mind Independence Extra time on your hands Freedom of space


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IF YOU DONT HAVE BASIC UNDERSTANDING OF FUTURESAND OPTIONS, PLEASE, DONT READ THE SECTION THATFOLLOWS.

2

Lets start with charts, which by many are considered to be thewindow to the markets soul


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DAILY CHART gives you a daily range of price in a particularcontract month (December Corn). This daily range is usuallyrepresented in form of a vertical bar. The length of the bar tells uswhat was the high and low on the particular date. One vertical barrepresents one days price action. So when you have number ofthose bars together, you have a graph of behavior of this particularcontract month over a certain period of time.

WEEKLY CHART gives you weekly price range. One vertical bar

represents one weeks price action. Top of the bar gives you highfor the week while bottom of the bar gives you low of the week.

MONTHLY CHART usually covers a period of ten, twenty or moreyears.One vertical bar represents one months price action. Thischart isvery important because it puts current futures prices in thehistoricalperspective.

For example, if you see that December Corn futures is traded at190, only after looking at the Monthly Chart in Corn you can realizethat for the Corn market, 190 is very low price , because usuallyCorn trades around 250-300.

So when you compare all of those charts, you will realize thatobjectively speaking being at 190, Corn is traded very low


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historically. So it seems that it is only a matter of time before the Cornprices start rising.

Here is the moment when Natural Wave Trading Theorycomesin. Itwill present itself to you through different examples that follow.

(Keep in mind that the Natural Wave TTshould be mainlyused in the markets that trade either very low or very highhistorically. Natural Wave TTis designed to help you withthe search of the bottom or top of the market. So inmy opinion it should be incorporated mainly in thosemarket conditions, which would indicate that possibly aparticular market is trying to make a bottom or top.)

Example 1:

You go long 1 December Corn from 205, and instead of the stoploss you buy December Corn 200 Put option, for 9 cents or $ 450(please be advise that the cost of the premium will vary in differentmarket conditions).

Your total riskon this trade is:

205 200= 5 cents ($ 250) + $ 450 (option premium cost + $50 commission) + $ 50 (Round Turn commission cost on 1 future contract)

Example 2:

How would your $ 1000 account look like if you used this method,

and if Corn dropped 20 cents or $ 1,000 against your futuresposition?

1. 205 20 = 185 (new price level of December Corn after 20cents decline),

2. The value of your 200 Put would be at least 15 cents or $ 750.


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3. Even though your option is appreciating, you cant use thisappreciation to offset your futures loss.

4. You could still be on a Margin Call even though your risk isvery well defined [remember (?), options are wasted assets].

5. After youve purchased your 200 Put option youve taken out ofyour account $ 500 ($ 450 premium + $ 50 commission).

6. So you have BALANCE of $ 500. But because youvepurchased the futures contract at 205 you have to pay halfcommission; on futures youpay halfcommissions when youget inand the second half when youget outof your trade.After paying $25 your BALANCE would be $ 475 (before thefutures market dropped 20 cents).

7. How could you trade then, if the initial margin in Corn is about$ 675 and you have only $ 475 balance? Well, most likely the

initial margin requirement your account (for this particular trade)would be reduced, because you have a 200 Put option forprotection, which makes your futures trade relatively safe. Andif an initial margin was imposed, most likely it would be for theamount of $250, which equals the distance between the buyprice of the future contract and the strike price of the option.

8. So Corn could drop 9 cents or $475 against you before youraccount balance becomes ZERO. And before youre on theMargin Call.

9. So in this case, if Corn price is at 185, chances are that youraccount will reflect a negative balance of $ 525 (475 1,000). Itwill be the same as Margin Call. You would be required toeither deposit to your account $525 immediately, or close yourposition.

10. If you choose to close your position, you could do it in twoways:

a) You could liquidate your 200 Put, and close your longCorn contract, by selling it. After that your account

balance would be about $ 200.

+ $ 750 (from liquidation of your 200 Put)+ $ 475 (your initial account balance before Corndeclined 20 cents)= $ 1,225.


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- $ 25 (half commission for sell of 1 contract)

Total = $ 1,200Minus $ 1,000 (205 185)

Ending Account Balance = $ 200.

b) You could exerciseyour 200 Put on Corn.And by doing so, you would be offsetting your longcontract with a sell at 200---remember that your 200 Putis your right to be short a futures contract from 200, ifyou choose. So in this case youve decided to utilize orexercise this right.

In this case your Ending Account Balance would bealso $ 200. How?

$ 475 (initial balance of the account, before 20 centsdecline) - $ 250 (205 200 (strike price))== $ 225.

$ 225 - $ 25 (half commission on the futures trade, whichwould happen when you exercise your 200 Put) = $ 200.

11. In both cases (liquidation and exercise) the EndingAccount Balance would be identical.

12. So, what is the advantage of LIQUIDATION vs.EXERCISE?

During very high volatility of the futures markets, optionspremiums could be trading in the fast mode. It means that if(for example) the last value of 200 Put was 15 cents or $ 750,when you sell it at the market, you might get for it only 12cents or $600, because somebody else had a bit to buy 200Put for 12 cents or better (If you think its not fair---too bad.Thats how markets work. You can either accept this as thepart of trading reality within which you have to operate,and be happy, or just simply walk away from tradingaltogether. But regardless what youll do do not whine.).


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In my opinion the best strategy in this case would be theexercise. During fast trading mode you want to be incontrol of your trading as much as you can. And with exercisinga 200 Put, you wouldve known all the numbers thuscontrolling all the pieces.

13. So why would you even bother with liquidating options,as opposed to exercising them whenever they are in themoney?

Because if you still have a lot of time left on your optionyou may have an extra time premium on top of your intrinsicvalue. In the described above case, instead of your 200 Putbeing worth 15 cents or $750, it could have been valued at 17

cents or $850, if there was still plenty of time until expiration.

Example 3: (Better scenario)

Since the market can move both ways, it can also work inyourfavor, so there is no need to always expect the worst.

You are long 1 December Corn from 205, and you have 200 Putas the hedge, for which you spent $500.

Then, over the next two weeks Corn goes to 250. And if you wereto close/exit your futures contract you wouldve made $2,250.

Wow you say.But dont forget that you have also spent money on your 200 Put.

So, your actual net profitwould be:

$ 2,250- $ 500 (option cost)

- $ 50 (round turn commission on the future contract)= $ 1,700

Youve made a cool $1,700 with very limited risk. And this is onlyon one contract. Try to imagine how much trading power you havewith this type of trading when you can have very limited risk andvirtually unlimited profit potential.


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Have you had just 10 contracts your profit potential would havebeen $17,000; on 100 contracts, it would have been $170,000.

(You still have 1, 200 Put option left. You bought it---youown it. It isnt worth much after Corn rallied to 250,maybe cent or $ 25, or maybe not even that. Byliquidating it now, you are not going to accomplish much.It is a better choice to just keep it if you still have one ortwo months left until its expiration- in case the Cornmarket declined sharply. In such case what could verywell happen is that your option might become worth a fewhundred dollars again. Since youre already out of yourfutures contract, this appreciation could be an extra (gift)profit that you didnt expect. At this point your original

$1,700 profit, which you had already taken, can growmuch more, thanks to this forgotten option, which wasalready discarded as the loss.)

What would be your account balance now, after you exited yourlong futures contract at 250, and after assuming that the remaining200 Put is worth ZERO?

$ 1,700+$ 450 (cash that left on your $1000 account after

$ 500 cost on 200 Put, and after paying $ 50Round Turn commission on futures contract)

=$ 2,150 (your new account balance)

Ibelieve that when you apply sound trading methodology, thereis a strong possibility that over an extended period of time you wouldbe able to take small trading account and turn it into a larger one.

SO FAR IVE DESCRIBED A SIMPLE TECHNIQUE OFHEDGING ONE FUTURES CONTRACT WITH ONE OPTION.


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HOWEVER, THE TRUE POWER OF THE NATURAL WAVETRADING THEORY IS IN MODIFICATION OF THIS ONE-ON-ONEAPPROACH.

Example 4:

To give yourself better a chance of succeeding intrading, Im hoping that you are able to start acommodities trading account with at least$5,000.

From here on, Im not going to break down specifictrade examples into the details, which includecommissions cost, margin requirement and accountbalance. You are smart enough to figure this on your own.

Youre going long 1 December Corn contract at the market (firstavailable price after your order hits the trading piton the exchange).Your fill price is 205.

At the same time you are buying: 1 200 Put for Dec. Corn. 1 190 Put 1 180 Put

Also youre placing following open orders (check with your brokerif youre not sure how they work): to Buy 1 Dec. Corn (future contract) @ 190 or lower, to Buy 1 Dec. Corn (future contract) @ 180 or lower.

If the futures market never comes down to 190 and starts goingUP, in order for you to break even, 1 Corn contract, which you boughtat 205, would have to go UP enough to cover the cost on 200 Put,190 and a 180 Put. So, if you spent $ 800 on your options, Cornwould have to go to about 221 before you break even on this wholetrade, assuming that you let your options expire worthless.

By the same token, if Corn declined to 179, or so, you would be aproud owner of 3 December Corn contracts with an average priceof about 191 .


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What actually happened, if Corn declined, is not only that you gotfilled on your future contracts opened orders (Buy at 190, Buy at180), but at the same time your 200 Put, 190 Put and 180 Putappreciated quite significantly. So even though you are loosing on thefutures sideof this trade, the options absorb some of this loss.These options also give you the confidence of knowing what is yourtotal risk exposure.

Sure, your account statement would show that you are losingabout $ 1,700, when Dec. Corn is trading at around 180. But it wouldalso show that the value of your Put options increased. And althoughoptions are wasted assets, you most likely could liquidate orexercise them, if you need to (and then they are no longer wasted intheir entirety).

Other words if Dec. Corn instead of going UP ended up declining

to 155, you probably would be on a margin call, because your losson 3 Corn contracts will be about $5,500, which is more than yourinitial starting capital of $5,000.

At the same time the values of your 3 Puts increased, and theircombined market value would be approximately $5,250.

So, if you dont want to add any more money to your accountwhen Corn futures is trading at 155, you simply would exercise your200 Put option. And with doing so about $2,250 would be released toyour accout, and you still will be in the market with 2 remainingfutures contracts, 190 Put, and 180 Put And if you believe thatCorn has still plenty of potential on the upside stay with your trade.Otherwise, close your position altogether and get ready for the nextone.

What could also happen is that Corn never dropps below 179, andbounces back to 205. At this point you would be making about $2,000on your 3 contracts (your average price is 191 ). Have you had only1 contract you would be about breaking even on your futurescontract.

It is apparent, how important cost average is in your trading.

It so, because of the cost averaging, you are insuring theaverage price on all 3 contracts of Corn at approximately 191 . Butdo not forget that, if you overextend yourself (you get too manycontracts) the cost averaging can turn disasterous (if youre not


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hedged with options). You may end up with the greater loss than youraccounts initial balance.

But lets get back to the scenario in which Corn never droppsbelow 179.

Lets assume that Corn (bouncing off 179 level) ended up makingthe sharp rally and you find yourself at the price of December Corn @271 . Also now you find yourself in a situation that seems also veryuncomfortable, almost as much as the losing situation.

Now you are making roughly $12,000 profit on your 3 Corncontracts. And even, if you subtract the loss on the 200, 190 and 180Puts (which probably would expire worthless), that still leaves you an

approximate profit of about $11,200 (including commissions).You could panic here because you could be thinking about a

down payment on the house or new BMW, or maybe those vacationsthat you were putting off year after year. And you might decide to takeprofit on all three contracts of Corn

Of course there is nothing wrong with taking profit, especially asnice as this one. What would be wrong though is to get out of themarket, which could possibly be on the way to reach the price level of400 or beyond. But of course we dont know that for sure.

The strategy I would propose at this moment would be getting out(selling) of 1 contract, and remaining in the market with 2. This way,since your cost average on 3 contracts was about 191 you areputting away about $4,000(271 - 191 = 80, 80 cents x $ 50 =$ 4,000).

And if Corn indeed went up all the way to 401 , you could bemaking 210 cents per contract. And since you had 2 contracts left,your profit would amount to 2 x 210 x $ 50 = $21,000.

Its almost hard to believe this, isnt it? And if scenarios such asjust described above dont happen every day, you as a trader want tobe ready to take adventage of them when they do happen. TheNatural Wave TTcould possibly help you with catching a majormove in the market. The Natural Wave TTcant make a decisionfor you though. You have to do your homework, get comfortable with


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the markets you trade, and then use the Natural Wave TradingTheory to possibly increase your chance of success.

Read as many books on trading as you possibly can, withoutgetting confused and having your head spinning. At the sametime dont lose the main objective you want to make moneyin trading, not just getting an intellectual stimulation

Because the time would come when you would have to makethe decision about your position in the market. And this iswhen from somewhat unemotional perspective- you wouldhave to look on all those oscillators and buy and sellsignals that youve read so much about. This is where you migth

find the Natural WaveTrading Theory to be quite handy. Forultimately you are as much after the unlimited profit potentialas you are after the limited risk.

Example 5:

Corn is trading around 210. You buy 1 contract and hedgingyourself with 210 Put.

Corn is declining to 200. You are adding 1 more contract (goinglong) and buying 200 Put as the hedge, and so on

You can use this strategy when you want to create solid hedge.In this case your Put options are at the money, any time you buythem. They cost you more, but also your hedge seems to be moreeffective -if the future market didnt go up soon, didnt go in thedirection of your futures contracts.

In this case you could start to liquidate or exercise Puts withhigher strike prices, one at a time, if you were running out of moneyfor initial margin, to support your futures side of the trade.


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Example 6:

This example relates to the market that is having a mid-range oftrading from the multi-years lows and highs. If youre expecting thatthe market is going to continue within certain price levels (like in Cornbetween 260 and 300), you could bracket this market with options inanticipation of trading futures contracts within the bracketed price.

Lets say that December Corn is traded at 282. Youre buying 260Put, and 300 Call.

If futures Corn goes down to (lets say) 262, youll buy1December Corn futures contract. And if from there Corn goes up toabout 296, you will be getting out of your long Corn taking profit- andinitiating sellof 1 December Corn, which will be your new short

position.In the described situation you are not using any stop losses, but

rather taking advantage of your 260 Put, and 300 Call, which youprobably purchased for cheap(originally when Corn was at 282) andusing them as protective hedges.

You were setting up your pieces strategically in anticipation of acertain development in Corn. You were building upyour position, asyour reactionto the Corn market development. Your reaction wasa result of seeing the Corn market from the perspective of severalyears. You had determined that Corn most likely was going to tradewithin 260-300 range. And when Corn was at 282 the price of 260 Putwas cheaper than it would be when Corn was at 262. Or by the sametoken, 300 Call was cheaper when Corn was at 282, than it would bewhen Corn prices reached 296 levels.

There are no guarantees in trading. But you as a trader have tolearn how to prepare yourselffor certain market conditions. And bypreparing yourself youll most likely have an edgethat would bringyou closer to becoming a successful trader.

The Example 6 could be developed into more leveraged positionthrough buying more Puts and Calls, and trading with multiple futurescontracts. This would even add more flexibility to your approach.However, the downside to this is that your cost on the trade/positionwould be higher. Yet, with the multiple contracts and options yourprofit could become much more significant as well.


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5. NEW BEGINNING

As you very well know there are different styles of trading infutures and options. Some even believe that there are as many stylesas traders. But only a small percentage of traders make money andsurvive on somewhat consistent basis- the commodities game.

natural wave trading theory[1]

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