TheStockAdvisor Advice

Fraud

Commodity futures and options are prime targets for fraudulent offerings. Usually these are cold calls or advertisements offering quick profits.

Look at solicitations which are based on seasonal changes or in response to publicly-issued reports or well-known current events.  For example, advertisements on radio or television may urge you to purchase commodity options in heating oil because increased demand for heating oil in the winter is likely to push up heating oil prices. Similarly, in the spring, advertisements may tout commodity options in unleaded gasoline because increased consumption of gasoline in the summer is likely to boost gasoline prices. Or you may receive a phone call from a salesperson urging you to invest quickly in futures for certain agricultural commodities because El Nino has driven up prices on those commodities or a recently-issued government report has described shortages of that commodity.

These sales pitches are false. Seasonal increases in the demand for commodities do not necessarily result in the increased value of an option or futures contract on those commodities because the market has already factored seasonal demand into the price of futures and options. The same is true of well-known information like El Nino or government reports. The markets respond immediately within a few hours, often a few minutes to new information. In other words, the prices of commodity options and futures contracts already take into account all known or predictable market conditions, such as seasonal changes in demand for a commodity or known shortages of a commodity. The advent of the summer and winter seasons, or the latest United States Department of Agriculture report on crop size, is not news that is known to only a few.

Moreover, claims that the risk of purchasing commodity futures and options can be predetermined or fixed are misleading. Purchasers of commodity option contracts can lose every penny of their investments and because futures contracts are "leveraged" or "margined," futures investors can lose more than their investments.

If you are solicited by a company that claims to trade commodities and asks you to commit funds for those purposes, you should be very careful. Watch for the warning signs listed below, and take the following precautions before placing your funds with any commodity trading company that offers leveraged or financed commodity transactions:

  • Avoid Any Company That Predicts or Guarantees Large Profits Because of Predictable, Seasonal Changes in Demand, Published Reports, or Well- Known Current Events
  • Stay Away from Companies That Promise Little or No Financial Risk
  • Be Wary of High-Pressure Efforts to Convince You to Send or Transfer Cash Immediately to the Firm, via Overnight Shipping Companies, the Internet, by Mail, or Otherwise
  • Be Skeptical about Unsolicited Phone Calls about Investments, Especially Those from Out-of-State Salespersons or Companies with Which You Are Unfamiliar
  • Prior to Trading, Contact the Commodity Futures Trading Commission or Other Authorities, Including Your State's Attorney General's Office's Consumer Protection Bureau, and the Better Business Bureaus and the National Futures Association
  • Be Sure You Get All the Information about the Company and Its Track Record and Verify the Data. If You Can, Before You Invest with Any Company, Check the Company's Materials with Someone Whose Financial Advice You Trust
  • Don't Deal With Individuals Who Won't Give You Their Background
  • If in Doubt, Don't Invest. If You Can't Get Solid Information about the Company and the Investment, You May Not Want to Risk Your Money

Now take a look at web sites selling commodity trading systems that guarantee high profits with minimal risks.

The United States Commodity Futures Trading Commission (CFTC), the federal agency that regulates commodity futures and options markets in the United States, has witnessed an increase in the number of Internet web sites fraudulently promoting commodity trading systems and advisory services. Among other things, these web sites falsely claim that advertised performance results are based on real trading when, in fact, the results are based on hypothetical trading. The CFTC urges you to be skeptical when promoters of trading systems and advisory services claim that their products and services will earn high profits with minimal risks. You also should be forewarned that systems that trigger frequent trading signals as part of a day-trading strategy could result in substantial commissions and fees.

HYPOTHETICAL TRADING RESULTS CAN BE UNRELIABLE

Many trading system promoters advertise their systems by reporting hypothetical trading results. Hypothetical trading results typically are based on trading simulations using historical price data or simulated "real time" computer trading. To obtain these results, trading system promoters typically pretend that they traded futures contracts at market prices that occurred some time in the past. They then calculate the trading results that these purported trades would have achieved had they been placed, based on actual historical prices. These results often show impressive trading results and large net profits with only a few, small margin calls.

Whether based on historical data or simulated "real time" trading, hypothetical results do not reflect the results of any actual trading. In other words, there is no actual futures account, no actual investment, no actual trading, and no actual profits. The results are purely the product of simulation.

Hypothetical trading results have several inherent limitations:

  • 20/20 Hindsight with Historical Results -- Since the trading systems that produced the results were not actually traded under real market conditions, the purported results fail to take into account market circumstances that affect traders and their decision-making process, such as anticipated news events that could have an impact on the supply, demand or price of the commodity.
  • "Real-time" is not Real -- When marketing trading systems, some promoters claim that their systems have performed successfully in "Real-time Trading." "Real-time Trading" only means that the system has been tested using a live data-feed, rather than being tested using historical market data. In "Real-time Trading," however, no trades have actually been placed in the market. Performance results based on "Real-time Trading" are merely a form of hypothetical results, with the same limitations.
  • Financial Limitations -- Hypothetical results may not adequately take into account the ability of a trader to absorb trading losses or to meet margin calls. Trading systems assume that the trader can withstand all losses generated by the system and can meet resulting margin calls. It is much easier to absorb a trading loss on paper (hypothetically) than to do so in reality. Many traders find it unacceptable to sustain several consecutive trading losses and/or margin calls. Moreover, in an actual trading environment, a trader's financial condition may change over time and affect his or her ability to continue following a trading system.
  • Not Tested Under Real Market Conditions -- Hypothetical trading results assume that futures contracts have been bought and sold at specific prices. Since these assumptions have not been subjected to actual market conditions, they may overestimate or underestimate the performance of a system. In addition, some market conditions may make it impossible to execute a trade. For instance, many systems assume that stop-loss orders will be executed at their stop price. Under actual market conditions a stop-loss order might be executed at a better or worse price, or not be executed at all. Further, actual market conditions include bid/ask spreads that might not be reflected in the prices used in hypothetical trading. Moreover, the actual execution of a trade could impact the price paid, especially in less liquid or illiquid markets.
  • Possible "Rigging" of Results -- A member of the public should be alert to the possibility that the system promoter manufactured results by selecting historical trades that would have yielded the greatest returns.
  • Trading and System Costs -- The profit claims of promoters may fail to take into consideration the cost of purchasing or leasing a trading system. While the prices of systems vary, many are sold for thousands of dollars. In addition, most of these systems require that the user obtain a data feed from a vendor. System promoters may also fail to take into consideration the impact on profits of commissions and fees charged by brokers in connection with futures and options trading. Such commissions can have a substantial effect on profitability, particularly when the system generates frequent trading signals. A user should take all of these costs into account because they raise the break-even point in trading.

Because of these limitations, CFTC Regulations require that the presentation of hypothetical trading results be accompanied by a specific cautionary statement warning of the inherent limitations of these results.

Now look at promises of easy profits from buying precious metals and other commodities.

Consumers should be alert to companies that sell investments in precious metals and other commodities based on sales pitches claiming customers can make a lot of money, with little risk, by purchasing metal through a financing agreement. Sometimes these companies offer opportunities to speculate on the price movement of precious metals, or other commodities such as heating oil, without actually taking delivery of the commodity.

The United States Commodity Futures Trading Commission (CFTC) is the federal agency that regulates the trading of commodity futures and options contracts in the United States and takes action against firms suspected of illegally or fraudulently selling commodity futures and options. Over the past several years, the CFTC has taken enforcement action against wrongdoers who lured customers to purchase purported interests in precious metals without taking delivery, through various misrepresentations including claims that they would earn large profits with little risk.

Certain companies advertise on radio, television or Internet web sites, or make telephone "cold calls," to promote the purchase of precious metals such as gold, silver and platinum. The advertisements, infomercials and telephone solicitations often promise quick riches - such as the ability to double or triple the customer's initial investment in just two or three months - all with low risk. Companies making such statements typically ask that customers pay only a small percentage of the total purchase price, and also claim that they (or another company) will purchase and store the metal. These companies also pretend to arrange financing for the customer's metal purchase so the customer can obtain a larger profit by controlling a larger amount of metal with their relatively small down payment. Companies often discourage customers from taking delivery of the metal. These companies often charge a commission for the purchase transaction, a loan origination fee, an interest charge on the remaining balance (which accrues over time), and fees relating to storage and shipping of the metal they pretend to purchase for the customer. Sometimes, not all of these fees are disclosed up front.

What's Wrong With Such Sales Pitches?

Companies making such pitches often:

  • lie about or overstate their ability to predict prices or the direction of the metals markets;
  • minimize the degree of investment risk involved in metals investments;
  • fraudulently fail to disclose how much the price of metal must go up for the customer to break even (let alone profit), since hefty finance and storage fees and commissions are deducted from the customer's account before any profits accrue;
  • falsely claim to be purchasing and storing the metal, when they do not actually do so. Indeed, companies often discourage customers from taking delivery of the metal;
  • charge phony "storage" fees for metal, when no metal is actually purchased or stored;
  • charge phony "interest" fees that diminish a customer's account equity to the point where the customer has to deposit additional funds with the company or have his account closed out at a total loss. The interest fees are phony because no metal has been purchased, as promised, and the financing arrangement therefore is fictitious;
  • fail to point out that, because you are buying on "margin" or with leverage, you will have to send the company additional funds (or sell a portion of your "metal position") if the price of the precious metals moves unfavorably.

Warning Signs Of Commodity "Come-Ons"

If you are solicited by a company to purchase commodities, watch for the warning signs listed below:

  • Avoid any company that predicts or guarantees large profits with little or no financial risk.
  • Be wary of high-pressure tactics to convince you to send or transfer cash immediately to the firm, via overnight delivery companies, the internet, by mail, or otherwise.
  • Be skeptical about unsolicited phone calls about investments from offshore salespersons or companies with which you are unfamiliar.
  • Be sure you get all information about the company and verify that data, if possible. If you can, check the company's materials with someone whose financial advice you trust.
  • Learn all possible information about fees and commissions charged, and the basis for each of these charges.
  • If in doubt, don't invest. If you can't get solid information about the company, the salesperson, and the investment, you may not want to risk your money

Use Extra Care When Dealing with Foreign Companies

Sometimes companies that solicit customer investments in precious metals (or their purported storage facilities) are located outside the United States, even if they do not reveal that fact to you while soliciting your investment. United States government agencies generally have little or no regulatory authority over entities operating outside the United States. If you transfer funds to foreign firms, or place funds with United States firms that are later transferred to offshore companies, it may be difficult or impossible for you to recover your money. Storing metal offshore, particularly in countries with secrecy laws, might make it difficult for you to verify your investment.

Ask where all companies that would handle your funds are located, where any telephone call you receive originates, where your funds will be deposited and kept, and where the metal will be stored. If possible, telephone the company.

Now we will take a further look at some of the potential shortcomings with commodity trading and trading systems.

Commodity trading systems typically are computerized programs that signal members of the public when to buy and sell commodity futures and options contracts. Systems produce buy and sell signals based on mathematical formulas and are typically based on technical analysis of trading data (trading volume and prices), as opposed to fundamental analysis (analysis of economic factors such as supply and demand). Trading systems that are based on technical analysis attempt to predict future price movements based on historical prices, price relationships and price trends.

In deciding whether to purchase a particular trading system to trade commodity futures or options, members of the public should remember that no commodity trading system can guarantee profits. And, whether or not a trading system is used, commodity futures and options are typically high-risk endeavors.

Persons considering trading commodity futures or options should educate themselves about futures and options and realize that they may lose large sums of money. The following checklist should help consumers in deciding whether to use a trading system.

CHECKLIST - IS A FUTURES/OPTIONS TRADING SYSTEM RIGHT FOR YOU?

  • Do you have the financial ability to sustain trading losses and meet margin calls? When trading futures contracts on margin, you risk losing much more money than the initial margin amount. If the market moves against you, you may be required to pay additional funds. The use of margin creates potentially large exposures to loss.
  • Can you lose your entire investment and more without a change in your lifestyle?
  • Do the trading results sound too good to be true?
  • Are the advertised trading results based on actual trading or "hypothetical" trading?
  • Has any trader used the system in actual trading? If so, how has the trader fared?
  • Will the system promoter provide you with independent verification of the claimed trading results?
  • What is the total cost of the system?
  • Have you factored into your purchasing decision the impact of commissions and fees that can result from frequent trading?
  • What are the additional costs (data feed, etc)?
  • Have you checked with the National Futures Association (NFA) whether commodity regulators have disciplined the system promoter? Not all system promoters are required to be NFA members or registered with the CFTC. A call to the NFA (800-621-3570 or 800-676-4NFA) or the CFTC, or a visit to the NFA's web site at http://www.nfa.futures.org, can confirm the status of a particular promoter.

Before investing, particularly in commodity futures and options, know and understand what you are getting into. Remember: "If it sounds too good to be true, it probably is too good to be true."


Disclaimer
- The information contained in the documents in this website should not be construed as an offer to sell, or a solicitation to buy, any securities referred to herein. The information is considered reliable, but not guaranteed as to accuracy or completeness. TheStockAdvisor specifically disclaims any liability in connection with the documents and/or information contained within this website.  See complete Disclaimer, SEC Compliance and Privacy Policy.

 
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