An awareness of patterns associated with support zones (areas usually associated with previous trading ranges, in which prices find support against further decline) and resistance areas (areas that resist further price advance) enables investors to more accurately define the diition of significant market trends. Such patterns also suggest areas in which price reversals are likely to take place.
Stock market advances do not take place in a straight line. They generally take place in a steplike series of advance, flat or retracement period, further advance, another flat or retracement period, and so forth.
During bull markets, retracements tend to take place at increasingly higher levels. The series of rising low areas between rising peak readings defines market trend.
Suppose, for example, that a stock is trading at a high of $50 per share, having recently risen in price from $45. A certain number of traders who purchased at $ will take profits at $50, creating, in the process, some temporary weakness in t stock. The stock might then back down to a price level of perhaps $47 to $48. If the general trend for that issue is bullish, which is the case in an uptrend, the will be buyers at hand waiting for a some reaction from the $50 level to take positions. If the buyers are aggressive, they likely will step into the market quickly, taking positions in the $47 to $48 area. This $47 to $48 area might be taken as an area “support,” a zone in which buyers will take positions in that issue.
Prices then rise, crossing the previous high at $50 (a temporary resistance ar because there was previous selling in that zone) and rising to perhaps $53 or when a new round of profit taking takes place. If prices back down, they are likely to find support in the area of the old previous high-in this case, in the ar around $50.
Each rise, retracement, and new rise during 1999 left behind a sort of indentatia in the chart pattern-a scoop of sorb, which represented a potential support zone for the next market declme. During uptrends, ideal buying zones often develop within those scoops or pockets between earlier market declines and the most rece market peaks.

In futures markets, the contracts have standardized terms and trade in a market that provides sufficient liquidity to permit the parties to enter the market and offset transactions previously created. The use of contracts with standardized terms results in relatively widespread acceptance of these terms as homogeneous agreed-upon standards for trading these contracts. For example, a U.S. Treasury bond futures contract covering $100,000 face value of Treasury bonds, with an expiration date in March, June, September, or December, is a standard contract. In contrast, if a party wanted a contract covering $120,000 of Treasury bonds, he would not find any such instrument in the futures markets and would have to create a nonstandard instrument in the forward market. The acceptance of standardized terms makes parties more willing to trade futures contracts. Consequently, futures markets offer the parties liquidity, which gives them a means of buying and selling the contracts. Because of this liquidity, a party can enter into a contract and later, before the contract expires, enter into the opposite transaction and offset the position, much the same way one might buy or sell a stock or bond and then reverse the transaction later. This reversal of a futures position completely eliminates any further financial consequences of the original transaction.
A swap is a variation of a forward contract that is essentially equivalent to a series of forward contracts. Specifically, a swap is an agreement between two parties to exchange a series of future cash flows. Typically at least one of the two series of cash flows is determined by a later outcome. In other words, one party agrees to pay the other a series of cash flows whose value will be determined by the unknown future course of some underlying factor, such as an interest rate, exchange rate, stock price, or commodity price. The other party promises to make a series of payments that could also be determined by a second unknown factor or, alternatively, could be preset. We commonly refer to swap payments as being “fixed” or “floating” (sometimes “variable”).
We noted that a forward contract is an agreement to buy or sell an underlying asset at a future date at a price agreed on today. A swap in which one party makes a single fixed payment and the other makes a single floating payment amounts to a forward contract. One party agrees to make known payments to the other and receive something unknown in return. This type of contract is like an agreement to buy at a future date, paying a fixed amount and receiving something of unknown future value. That the swap is a series of such payments distinguishes it from a forward contract, which is only a single payment. Swaps, like forward contracts, are private transactions and thus not subject to direct regulation. Swaps are arguably the most successful of all derivative transactions. Probably the most common use of a swap is a situation in which a corporation, currently borrowing at a floating rate, enters into a swap that commits it to making a series of interest payments to the swap counterparty at a fixed rate, while receiving payments from the swap counterparty at a rate related to the floating rate at which it is making its loan payments. The floating components cancel, resulting in the effective conversion of the original floating-rate loan to a fixed-rate loan.
Forward commitments (whether forwards, futures, or swaps) are firm and binding agreements to engage in a transaction at a future date. They obligate each party to complete the transaction, or alternatively, to offset the transaction by engaging in another transaction that settles each party’s financial obligation to the other. Contingent claims, on the other hand, allow one party the flexibility to not engage in the future transaction, depending on market conditions.

In this post, we take a brief look at the different types of derivative contracts. This brief treatment serves only as a short introduction to familiarize you with the general ideas behind the contracts.
Let us start by noting that derivative contracts are created on and traded in two distinct but related types of markets: exchange traded and over the counter. Exchange-traded contracts have standard terms and features and are traded on an organized derivatives trading facility, usually referred to as a futures exchange or an options exchange. Over-the-counter contracts are any transactions created by two parties anywhere else. We shall examine the other distinctive features of these two types of contracts as we proceed. Derivative contracts can be classified into two general categories: forward commitments and contingent claims. In the following post, we examine forward commitments, which are contracts in which the two parties enter into an agreement to engage in a transaction at a later date at a price established at the start. Within the category of forward commitments, two major classifications exist: exchanged-traded contracts, specifically futures, and over-the-counter contracts, which consist of forward contracts and swaps.
The forward contract is an agreement between two parties in which one party, the buyer, agrees to buy from the other party, the seller, an underlying asset at a future date at a price established at the start. The parties to the transaction specify the forward contract’s terms and conditions, such as when and where delivery will take place and the precise identity of the underlying. In this sense, the contract is said to be customized. Each party is subject to the possibility that the other party will default.
Many simple, everyday transactions are forms of forward commitments. For example, when you order a pizza for delivery to your home, you are entering into an agreement for a transaction to take place later (“30 minutes or less,” as some advertise) at a price agreed on at the outset. Although default is not likely, it could occur-for instance, if the party ordering the pizza decided to go out to eat, leaving the delivery person wondering where the customer went. Or perhaps the delivery person had a wreck on the way to delivery and the pizza was destroyed. But such events are extremely rare.
Forward contracts in the financial world take place in a large and private market consisting of banks, investment banking firms, governments, and corporations. These contracts call for the purchase and sale of an underlying asset at a later date. The underlying asset could be a security (i.e., a stock or bond), a foreign currency, a commodity, or combinations thereof, or sometimes an interest rate. In the case of an interest rate, the contract is not on a bond from which the interest rate is derived but rather on the interest rate itself. Such a contract calls for the exchange of a single interest payment for another at a later date, where at least one of the payments is determined at the later date.
As an example of someone who might use a forward contract in the financial world, consider a pension fund manager. The manager, anticipating a future inflow of cash, could engage in a forward contract to purchase a portfolio equivalent to the S&P 500 at a future date-timed to coincide with the future cash inflow date-at a price agreed on at the start.
In this manner, the pension fund manager commits to the position in the S&P 500 without having to worry about the risk that the market will rise during that period. Other common forward contracts include commitments to buy and sell a foreign currency or a commodity at a future date, locking in the exchange rate or commodity price at the start.
The forward market is a private and largely unregulated market. Any transaction involving a commitment between two parties for the future purchaselsale of an asset is a forward contract. Although pizza deliveries are generally not considered forward contracts, similar transactions occur commonly in the financial world. Yet we cannot simply pick up The Wall Street Journal or The Financial Times and read about them or determine how many contracts were created the previous day.4 They are private transactions for a reason: The parties want to keep them private and want little government interference. This need for privacy and the absence of regulation does not imply anything illegal or corrupt but simply reflects a desire to maintain a prudent level of business secrecy.
Recall that we described a forward contract as an agreement between two parties in which one party, the buyer, agrees to buy from the other party, the seller, an underlying asset at a future date at a price agreed upon at the start. A futures contract is a variation of a forward contract that has essentially the same basic definition but some additional features that clearly distinguish it from a forward contract. For one, a futures contract is not a private and customized transaction. Instead, it is a public, standardized transaction that takes place on a futures exchange. A futures exchange, like a stock exchange, is an organization that provides a facility for engaging in futures transactions and establishes a mechanism through which parties can buy and sell these contracts. The contracts are standardized, which means that the exchange determines the expiration dates, the underlying, how many units of the underlying are included in one contract, and various other terms and conditions.
Probably the most important distinction between a futures contract and a forward contract, however, lies in the default risk associated with the contracts. As noted above, in a forward contract, the risk of default is a concern. Specifically, the party with a loss on the contract could default. Although the legal consequences of default are severe, parties nonetheless sometimes fall into financial trouble and are forced to default. For that reason, only solid, creditworthy parties can generally engage in forward contracts. In a futures contract, however, the futures exchange guarantees to each party that if the other fails to pay, the exchange will pay. In fact, the exchange actually writes itself into the middle of the contract so that each party effectively has a contract with the exchange and not with the other party. The exchange collects payment from one party and disburses payment to the other.
The futures exchange implements this performance guarantee through an organization called the clearinghouse. For some futures exchanges, the clearinghouse is a separate corporate entity. For others, it is a division or subsidiary of the exchange. In either case, however, the clearinghouse protects itself by requiring that the parties settle their gains and losses to the exchange on a daily basis. This process, referred to as the daily settlement or marking to market, is a critical distinction between futures and forward contracts. With futures contracts, profits and losses are charged and credited to participants’ accounts each day. This practice prevents losses from accumulating without being collected. For forward contracts, losses accumulate until the end of the contract.’
One should not get the impression that forward contracts are rife with credit losses and futures contracts never involve default. Credit losses on forward contracts are extremely rare, owing to the excellent risk management practices of participants. In the case of futures contracts, parties do default on occasion. Nonetheless, the exchange guarantee has never failed for the party on the other side of the transaction. Although the possibility of the clearinghouse defaulting does exist, the probability of such a default happening is extremely small. Thus, we can generally assume that futures contracts are default-free. In contrast, the possibility of default, although relatively small, exists for forward contracts.
Another important distinction between forward contracts and futures contracts lies in the ability to engage in offsetting transactions. Forward contracts are generally designed to be held until expiration. It is possible, however, for a party to engage in the opposite transaction prior to expiration. For example, a party might commit to purchase one million euros at a future date at an exchange rate of $0.85/€. Suppose that later the euro has a forward price of $0.90/€. The party might then choose to engage in a new forward contract to sell the euro at the new price of $0.90/€. The party then has a commitment to buy the euro at $0.85 and sell it at $0.90. The risk associated with changes in exchange rates is eliminated, but both transactions remain in place and are subject to default.’

The concept of risk is at the heart of investment management. Financial analysts and portfolio managers continually identify, measure, and manage risk. In a simple world where only stocks and bonds exist, the only risks are the fluctuations associated with market values and the potential for a creditor to default. Measuring risk often takes the form of standard deviations, betas, and probabilities of default. In the above simple setting, managing risk is limited to engaging in stock and bond transactions that reduce or increase risk. For example, a portfolio manager may hold a combination of a risky stock portfolio and a risk-free bond, with the relative allocations determined by the investor’s tolerance for risk. If for some reason the manager desires a lower level of risk, the only transactions available to adjust the risk downward are to reduce the allocation to the risky stock portfolio and increase the allocation to the risk-free bond.
But we do not live in a simple world of only stocks and bonds, and in fact investors can adjust the level of risk in a variety of ways. For example, one way to reduce risk is to use insurance, which can be described as the act of paying someone to assume a risk for you. The financial markets have created their own way of offering insurance against financial loss in the form of contracts called derivatives. A derivative is afinancial instrument that offers a return based on the return of some other underlying asset. In this sense, its return is derived from another irlstrument-hence, the name.
As the definition states, a derivative’s performance is based on the performance of an underlying asset. This underlying asset is often referred to simply as the underlying.’ It trades in a market in which buyers and sellers meet and decide on a price; the seller then delivers the asset to the buyer and receives payment. The price for immediate purchase of the underlying asset is called the cash price or spot price. A derivative also has a defined and limited life: A derivative contract initiates on a certain date and terminates on a later date. Often the derivative’s payoff is determined andlor made on the expiration date, although that is not always the case. In accordance with the usual rules of law, a derivative contract is an agreement between two parties in which each does something for the other. In some cases, as in the simple insurance analogy, a derivative contract involves one party paying the other some money and receiving coverage against potential losses. In other cases, the parties simply agree that each will do something for the other at a later date. In other words, no money need change hands up front. We have alluded to several general characteristics of derivative contracts.

This struggle between investor creditor and company debtor is part of a mismatch of their risk-return appetites. Yet, there are various types of investor in the risk universe. Some are risk-bearing, some are risk-offering players.
Professional investor/shareholder
This category includes the class of professional investor – those who work in banks, fund managers and financial institutions. There are many sophisticated investors who are busy creating their own pension or playing with more than $100 000 to $1 million. They invest to accumulate wealth, sometimes losing on the way. But, this is a burgeoning section of the population.
These individuals operate in addition to the full-time professional bank/fund managers who are investing far larger sums. The different types of investor classes take various time horizons, trading strategies and asset classes.
A conservative or risk-averse investor would like to preserve the value of the original in- vestment, hence to limit the downside risk, and to make a “reasonable” return.
A risk-seeking investor or speculator, on the other hand, can be eager to engage in “double or quits” wagers on the stock market – such as Internet day-traders. In fact, it is often worse than a zero-sum game; after spreads, commissions, fees and taxes, at least 70 % of these short-term traders lose money. It is an uneven playing field just like a casino’s rules: the house always wins.
Yet, there are those in the majority of investors who take a longer term view and believe in the “prospects” of a company. These are the “rational” investors, both big and small, who occasionally get “suckered” into buying a bad stock. The stock-market crashes of 1929, 1987 or September 11th 2001, and the continuing bear run in 2003 offer testimony to the fickleness of share prices. Disaster is good for risk management business but bad for the traditional “buy-and-hold” investor philosophy.
Investment companies/Fund managers
The market is potentially teaming with sharks ,which is why we hire seasoned managers who protect us and nurture our wealth. The directors of investment companies are meant to be professionals who are hired for their ability to create and preserve shareholder value. But, when they fail, the business world either rails against investor injustice, or quietly suffers in silence, which offers no solution. Fortunately, there has been some good research done to search for effective corporate governance solutions.
Investmentbanks
These are the professionals who often rest at the centre of the market action. There are corporate bankers, brokers, company analysts who have been deemed skilled and ethical to handle the vast and valuable amounts of data in the market. Banks are paid to analyse target companies’ prospects, and also to finance and sell these companies to the investor. The chef is cooking, tasting and recommending the same dishes to customers. These roles have conflicts of interest
that have led to successful lawsuits against some Wall Street banks. Some investment banks have split their stock broker and analytical arms from their investment banking arms into different companies. It will not be a complete solution to the conflict of interest that led to the division along ‘ChineseWalls’.

The stock-market collapse has emphasised the topsy-turvy world of investor euphoria and dismay. The shareholder public has suffered a crisis in confidence in those charged with the management of their investment, chiefly the corporate directors or CEOs.
There has been a significant impact from corporate accounting scandals as two-thirds (62 %) of UK private investors are now less trusting of all company reports and accounts.
What is true seems to be a disconnection between real risk and a perceived “good investment” and the investor votes with his wallet.
Certainly, the investor has turned to regulatory safeguards in desperation, but the protection may turn out to be rather cosmetic at times. More realistically, there is a limit to help and compensation that can be provided post facto. Or that the public naively placed too much faith in the FSA, SEC or FDIC in getting back all (or most) of their losses. This market is full of unrealistic expectation.