Often traders take this to mean that the price must retrace or pullback from the high.  This is a big mistake, because mathematically, what is happening in the calculation of the indicator is that as each new bar is added to the price, another bar further back must be subtracted.  If the new bar is higher and the old bar is lower, you will get a classic divergence in the indicator.

Think of this phenomena of a fat man getting off a teeter totter with multiple small children on the other side.  Conversely if more and more small children get on the teeter totter, they can out weigh the fat man.

Another outcome of a Classic Divergence is that the price simply goes flat for a period of time, or you get a second or even third divergence.  Be cautious when trading divergences.  They can fool you, especially in a long up trend.

I encourage you to be observant of the strength of the divergences that occur when the trend that is changing is rapid or slow.  We have an excellent video that shows this effect  with a triple classic divergence.

What is an option on a future? An option gives the buyer the right but does not obligate him to buy or sell a particular futures contract at a set price at any time prior to a specific date. When the option is exercised, it is the actual futures contract that is delivered to settle the transaction, not cash.

How are options and futures different? While often confused, there are distinct differences between these two financial instruments. When purchasing an option, the buyer is purchasing the opportunity to buy or sell a futures contract by a certain date. To acquire the option, the buyer pays an up-front fee (called the premium). He can choose not to exercise his option and, therefore, accepts no risk. All risk resides with the writer of the option who is obligated to the sale or purchase if the buyer chooses to exercise his option. With futures, the contract binds both sides equally. Both buyer and seller share the risk and both make a good-faith deposit (called margin) to guarantee that they will meet their financial obligation. The buyer must buy and the seller must sell at the agreed price on the agreed date.

There are two types of futures options:

• Call options: The buyer of a call option buys the right but is not obligated to buy a particular futures contract at a set price at any time before the option expires.
• Put options: The buyer of a put option has the right but is not obligated to sell a particular futures contract at a set price at any time before the option expires.

In trading options on the futures market, futures traders need to be aware of and understand the relationships between:

• the futures contract and the commodity, security or index being traded and
• the relationship between the option and the futures contract.

It is this last point that makes trading in futures options both complicated and volatile. While there is tremendous potential for profit and risk is limited to the up-front cost, traders unfamiliar with options can quickly run amuck. Success is in large part dependent on the trader’s ability to accurately anticipate future price levels, a combination of experience, skill and feeling for the markets.

In our next several posts we’re going to focus on each element of success. Today, let’s talk about money management.

Show Me the Money

Good money management is critical to success as a futures trader. You need to know:

• how to track of your results
• how to budget and set aside risk capital
• how to diversify
• and, as song goes, when to hold, when to fold and when to walk away.

Keep track. No matter how big or small the trade, always track your results. Keep a daily scoresheet so you know to the second how far ahead or behind you are. It’s essential information in planning your next move and deciding how much risk you can afford. You should also keep a daily trading diary that tracks not only your trades but the rationale behind your decisions, market factors you weighed, how you reacted, even how you felt that day. Periodically reviewing your diary will help you identify behavioral patterns so you can continually improve your technique.

Budget your risk. It’s like they say in Vegas, don’t gamble with money you can’t afford to lose. It’s the same with futures trading. Don’t trade with the rent or grocery money. Budget an amount you can afford to risk and stick to your budget. Trading funds should be considered venture capital — it might pan out, it might not. Trade small and learn your system before you increase your risk.

Diversify. You diversifying to decrease your risk. If you put all your eggs in one basket and win, you win big; but if you lose, you lose big. Divide your investment between several options and no one move will blow you out of the water. Your wins may be smaller but they’ll become more consistent and more numerous. In the long run, you’ll come out ahead.

Listen for alarm bells. As Kenny Rogers sings in The Gambler: “You got to know when to hold ‘em, know when to fold ‘em, know when to walk away and know when to run.” If you can’t walk away from a trade when something doesn’t seem right, you’ve got a problem. You have to listen for those internal alarm bells. Futures trading is like poker. For the uninformed and unwary it’s a high-stakes game of chance where the possibility that you’ll lose your shirt looms large. For the savvy and experienced trader, it’s a game of skill, technique and money management with the potential for huge rewards. The trick is in knowing the difference.

Visit the Futures Trading Secrets website to find out how you can master the essential elements of futures trading and learn the expert secrets that will allow you to become a successful futures trader.

Stay tuned. Next time: Psychology