Dear Fast Break Reader,

Welcome to the inaugural edition of Fast Break "Ask an Expert". Today's market expert is Dave Hightower.

David is the president of The Hightower Report, which has just launched its new Research Center at www.futures-research.com. Since starting his company in 1990, Dave has made it his goal to provide the most comprehensive, professional research possible to the trading public. The new Research Center is the closest he's come to achieving that goal so far!

Mr. Hightower is a pioneer in the stock index sector. He was one of the first paid, full time analysts covering those markets when they began to trade back in the early 1980's and has been at it ever since. Prior to establishing The Hightower Report, he was the Director of Research at Stotler & Company, then the world's largest commodity brokerage firm. In that role, Mr. Hightower oversaw a department that consisted of more than 40 analysts, covering just about every sector of the marketplace.

In total, Mr. Hightower has had 23 years of very intensive commodity research experience in nearly every aspect of the futures industry. Mr. Hightower is a frequent guest on CNN, Bloomberg Television, and many other industry programs.

Complimentary Trial Offer to The Hightower Report's Total Commodity Research Center

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Today, David will be answering questions submitted by our Fast Break readership. If you would like to submit a question for consideration to a future edition of Fast Break "Ask an Expert", please go to http://partners.futuresource.com/fbp/expertquestions.jsp. Due to the number of responses we generally receive, please submit only one question per week.

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Fast Break "Ask an Expert"
Today's Expert: David Hightower

Dear Fast Break Readers,

Thanks to all who submitted questions for this week's newsletter. It's exciting to see so many traders asking astute and inquisitive questions, as it can only help you improve your trading arsenal.

Today, I'll be responding to thirteen of your questions.

David from Arizona asks:

David, how do you see the increase in trading volume from managed futures and hedge funds affecting volatility in the futures markets over the next ten years?

David responds:

Overall, greater concentrations of hedge and fund money should exaggerate highs and lows, but we also expect physical hedge activity to increase, which could in a sense expand volatility further. In the end, the presence of concentrated trading volume should have the effect of making supply shortages and supply surpluses a reason to drive commodity prices to extreme levels.

Mark from California asks:

Once a trend has been established, is there any way to determine how strong or sustained the trend will be?

David responds:

Some technical and wave count followers suggest that the duration of trends can be predicted, but with the new world order and the potential for drastic overnight paradigm shifts, it is possible that trends will become compressed compared to historical standards.

Ruben from Canada asks:

Why do you recommend mostly buying options when the majority of them expire worthless and the professionals almost never buy them? The odds are on the side of the professionals; wouldn't it be fairer to level the "playing field" by recommending the buying and selling as well?

David responds:

Just because many have lost money being long premium doesn't mean that the tool was being used properly. In fact, in every type of strategy the overwhelming majority of traders using that strategy don't end up making money. We also think that while past doldrum-type commodity markets might have resulted in more long-premium losses, there is significant potential that volatility is going to continue to expand, leaving the long premium players with an advantage.

I also think that massive increases in volatility could enhance the return potential of options at the same time that traders might need to define risk. Conditions like mad cow, Al-Qaeda, bird flu or other surprise events can completely change the market’s reality overnight, and that requires an enhanced measure of risk control.

In my opinion, most “old adage” rules are worthless, and the professional's intent to sell premium in the current and future wild market structure might leave the professional traders in an "unprofessional" situation.

Rob from Australia asks:

Once a long-term trade has commenced, what is the best way to maintain such a trade, and as contracts reach expiry how does one roll over to the next periodic contract?

David responds:

To be honest, I have only personally ridden two trades beyond the 1-year contract listing cycle - the 1995/1996 corn market and the current corn and soybean event! In each case, I was set up for the trade with far out of the money multiple call option positions that were married to short futures. In each case, I used setbacks against the trend to cheapen my call costs, which in turn strengthened my resolve.

In fact, it would be a very difficult psychological haul to weather a major trend event without a risk control mechanism. My trading style is also different from many people, as I hope to restrict my trades to big, epic-potential scenarios. Sometimes I think traders look too hard for trades. One should be compelled to trade!

Jaime from Colombia asks:

How do you foresee the evolution of the gold market in the near future?

David responds:

Keep in mind our opinion on gold was documented to be turning bullish in July 2002 with a special report entitled "Gold: A Return to Glory." It turned even more bullish in November 2003 with another special report, this one entitled "Economic Recovery: A Rising Tide Lifts all Boats", and then even more bullish with a December 2003 special report titled "Gold: Another Wave Higher". (Our Special Reports are available to our Research Center subscribers at www.futures-research.com).

In short, we are not “Johnny Come Lately” bulls to the gold market. We think that gold is set to return as an entrenched investment tool and that inflation will return enough to give gold a follow-through lift in the remainder of 2004! In a sense, gold regains the luster that the central banks attempted to remove in the late 90's. Terrorism, international tensions, wild currency fluctuations and worldwide commodity shortages play right into the gold bugs’ hands!

George from Florida asks:

Do you believe that physical assets---commodities---will soon rise to the forefront of the average investor's mentality, so that we may see a similar explosion as we saw in the record climb of the Dow---paper assets ???

David responds:

We think that the commodities are already in that motion, but it is different for the hard assets because they look to be driven higher by a combination of physical demand and speculative fervor. In fact, we think the current commodity price swing is the beginning of the first modern day realization that the world's resources will not be distributed without some significant gyrations in price.

Furthermore, commodities have been out of vogue for so long that they might have significant appreciation ahead. Can a 10 pound bag of potatoes really only cost $1.70 and a bushel of oats only $1.89? With nearby US sugar recently trading below 5 cents per pound, we have to think that prices can rally a long way.

We also doubt that physical users are close to cutting back their consumption because of high prices, as companies like donut makers can easily make money even if the nearby price of wheat soars above $6.00 per bushel. Apparently $37 crude oil and nearby unleaded futures prices of $1.15 a gallon have little impact on retail energy demand. Therefore, the time for commodities is now!

Richard from Florida asks:

What is your favorite indicator or chart pattern for spotting reversals in the S&P mini when day-trading?

David responds:

I rarely day trade, but I have found that on a daily chart, seeing a big spike down range followed by a reversal within the session can be a sign that the selling has exhausted itself. In other words, when a market really hammers down but manages to recoil from the lows and close above the mid point of the range that can be a good signal for a major bottoming. Go back and look at the history, it is something to consider!

GR from Kansas asks:

I have bull call spreads in both silver and soybeans. Both have long calls way in the money and the short calls move right with them. To me this does not make sense.

David responds:

Initially, that could have been a temporary development in the initial stage of volatility expansion, as spec players threw money at the out-of-the-money options to catch part of the move. However, now that the calls have moved deep into the money, the trade has hit maximum profitability, as both options are effectively offsetting each other.

Bull call spreads have a maximum profit potential, which is the difference between the two strikes/less the premium paid! Sometimes with significant time value in the options and extreme volatility shifts, the spread can temporarily offer more than the on-paper maximum profit!

Greg from Illinois asks:

What is a good rule of thumb to use for when and by how much to adjust stops when a trade moves in the desired direction?

David responds:

I don't think that stop adjustment can be given a rule of thumb, as a number of elements dictate where to put stops. For instance, if the potential in the trade is massive or current volatility is high, then one has to be willing to use a wider stop.

If the market is massively overbought in the fund and small spec position, then a tight stop might be advisable, as a minimal failure on the charts could suddenly result in a capital or margin sell off.

We also think recent chart consolidation levels, trend lines, moving averages and other technical indicators are good tools to use in selecting a stop level. We also like to use a combination technical/fundamental stop, which is derived by chart levels obtained around the last significant fundamental flash point!

John from Bundaberg asks:

Could you please explain in layman terms C.F D's? Attended a seminar recently, where the presenter touched briefly on this subject.

David responds:

C.F.D's are basically the ability to bet on the amount of change from entry to exit in a given instrument with the added incentive of trading on margin. In other words, it is a way to be long or short a stock without taking physical delivery or putting up the entire cost of the security.

There is a leverage benefit and the ability to sell short, but liquidity might be a problem. In short, this is just another variation of individual stock futures.

Muhammad from Pakistan asks:

What do you say about the PGM metals and gold? What are your comments about the trends in metals?

David responds:

While there is a fundamental justification for soaring platinum and palladium prices (supply is tight due to a lack of recovery in Russian output & demand is expanding), one would think that platinum prices above $950 have factored in a significant tightness. Recently, GM threatened to switch from platinum to palladium, and that could begin the topping process. However, if the world economy springs into a sustainable recovery, that could give platinum another leg up.

We actually think that gold and silver began the transition from a flight to quality investment to a physical commodity/inflation play with the break on April 13th. If the platinum market goes to $1,000, then we suspect that both gold and silver are cheap at this week's lows (gold around $406 silver around $7.35). We think the trend in gold and silver will remain up but in order to really soar, we have to see either grains or energies prompt an inflationary threat!

Jamie from Iowa asks:

How do you determine if an option is overvalued or undervalued and is there a way to tell via option trading that a move is about over?

David responds:

In every market there are standard volatility levels and there are extreme historical type ranges. While current conditions look to be different than they have in the past, one has at least a starting point in determining over and undervalued signals.

Secondly, the potential for major events spark a significant price move (up or down) tends to make us discount the importance of volatility. We also have a rule of thumb: when one can sell an at-the-money call and buy more than three third-strike-out calls for almost even money, the market has extremely low volatility. On the other hand when one can't buy a fourth-strike-out option for less than a futures margin, volatility is expensive.

However, rules of thumb always have exceptions. For instance, being long an expensive at-the-money soybean call was a better long play than a being long futures going into the beginning of April 2004. In other words, sometimes the prudent play is to accept the volatility. In the soybean market, the current high volatility pushes the prudent player to multiple out-of-the-money long calls or a long futures/short out-of-the-money call/long the at-the-money puts.

Rebecca of China asks:

Kindly let me know your opinion about soybeans and soybean oil of CBOT for May, Jul and Sep. Will they keep firm or go down? And please let me know your opinion of the USDA report which was issued on Apr. 08, 2004, particularly in South American soybean production. My company’s view is Brazil 53mmt, Arg. 34mmt. What do you think about it?

David responds:

The Supply/Demand report was considered bullish, as the USDA pegged ending stocks at just 115 million bushels versus expectations of unchanged from last month’s estimate at 125 million bushels and compared to 178 million bushels for the 2002/03 crop year. Domestic crush and exports were revised higher.

Brazil’s production was pegged at 56 million metric tons versus 59.5 reported last month. Argentina’s production came in at 35 million metric ton versus 36.5 million reported last month. World ending stocks came in at 33 million metric tons versus 35.88 million reported last month and 39.27 million for the 2002/03 crop season. Other, more recent trade estimates for Brazil are coming in well below this level.

The Brazil Association of Vegetable Oil Industries pegged the crop at 52.8 million tons from 56.9 million tons as their previous forecast. A smaller than expected South America crop could put more reliance from world importers on the US crop, both old and new crop.

We would not argue with your 53 million ton estimate for Brazil, but your Argentina estimate could be a bit high. If Argentina production is near 32.5 and Brazil 53, world ending stocks could drop to 27.5 million tons from 39.3 million last year. We doubt that soybean supplies would get this tight without making a run at all-time highs at $12.90!

Regarding forecasting a range for the next day, some brokers use a “pivot point" for support and resistance levels. In our website, www.futures-research.com our Research Center subscribers can view a Daily Technical Commentary for each market, which includes daily, weekly and monthly charts and a written analysis on the market. The data tables a section entitled “Daily Swings,” in which you will find the pivot price and the key support and resistance points on each side of the pivot. We also include moving averages (20, 40 and 60 day), RSI and stochastics.

That's it for this edition of Fast Break "Ask an Expert".

Remember to sign up for your complimentary Trial Offer to The Hightower Report's Total Commodity Research Center. The Total Commodity Research Center contains all the fundamental and technical information you need. Take advantage of this special offer - go here to sign up!

Thanks for reading,
David Hightower

The views presented in this newsletter are not necessarily the views of FutureSource L.L.C.

Statement of Disclaimer: This report includes information from sources believed to be reliable but no independent verification has been made and we do not guarantee its accuracy or completeness. Opinions expressed are subject to change without notice. This report cannot be construed as a request to engage in any transaction involving the purchase or sale of a futures contract and/or commodity option thereon. The risk of loss in trading futures contracts or commodity options can be substantial, and therefore investors should understand the risks involved in taking leveraged positions and must assume responsibility for the risks associated with such investments and for their results.