Futures Trading — The Close

You have heard it before, “Gold Closed $2.50 higher today” the talking heads on TV reading off their teleprompter. For most people it’s just an interesting tidbit, even for most futures traders the ‘close’ seems to be an arbitrary number. But the close is so much more.

VWAP

For futures trading done on the exchange (I’m going to focus only on the CME) all volume, trades and prices are reported. Unlike FX this allows futures trading to be closely monitored and subject to more stringent rules.

When traders talk about ‘the close’ they are most likely referring to the period in which the day’s settlement price is determined. Our example above ‘GCK’ (the active gold futures contract on COMEX) settles by a volume weighted average price, VWAP, measurement between 1:29 and 1:30 pm Eastern Time. All electronic trades placed through GLOBEX (part of the CME) in the active month’s contract for gold are taken to calculate the VWAP rounded to the nearest tick. This is your daily settlement.

Settlement Comparisons

I personally find it interesting how much importance is attached to the settlement price by retail traders and daily news outlets. For institutions the settle is critical because it can affect their hedging schedules, commodity index averages as well provide contractual triggers for derivatives.

The settle doesn’t reflect important market highlights throughout the day which are important for smaller traders. It doesn’t tell you the high, it doesn’t tell you the low, it only captures one small aspect of the day’s range. In fact, I have seen days where the difference day over day on the settle was less than $.30, just 3 ticks. Yet the daily range was nearly $30 in gold, around 300 ticks. If you are only looking at settles you leave out a lot of information important to the market.

I’ve been using gold as an example but WTI, Brent, all softs (agricultural products) and virtually everything that is traded as a futures contract has a settlement procedure.

Trading the Close

If you trade a specific market long enough you can get a ‘feel’ for how the day’s close will resolve. Will gold rally into the close? Will it sell off? I’d argue trading around the close for each market is often a completely separate discipline than trading the future over longer periods even within the same instrument.

Some futures markets allow you the ability to buy or sell at TAS or trade at settle. This guarantees you the settlement price. Why would you want this? As a retail trader you can use this as your stop effectively pre-closing your position to be flat after the settle occurs. By doing so you allow yourself to try to beat VWAP during the settle. Beating VWAP is often more important to hedgers and commodity index traders since that is often how they are benchmarked.

Trading against the settle is just a different way to trade the same markets.

Some Settle Dynamics

Because of the way a lot of producer contracts are structured and written by major banks the settlement of a futures contract can often trade independently from the price action of the day. This is due to massive hedging volume needing to occur during the settle, a period of only 1-2 minutes for most futures contracts (you can look up exact daily settlement procedures on the CME’s website). Because of this, settlement price action tends to mirror itself closely on consecutive days during the month.

Trading closes often feels like trading a data release, except you don’t know what the data just came out. Sometimes the price action is clear and obvious and continues one way until the end of the close while others you need to sit back and stay out because the whipsaw is going to make VWAP virtually impossible to predict.

Next time you hear ‘Gold Closed $2.50 higher today” look a little bit deeper and see what really went on during the day’s close!

Nothing here should be taken as financial advice, views are the opinion of the writer, please consult your financial adviser on investment strategies suitable for you.

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