My name is Barbara Cohen and I am the CIO of Shadowtraders.com. But more than that…I am a Futures Trader, a Futures day-trader. When I first began trading over 10 years ago, at the time I was a computer programmer and I wrote software for automated black boxes. My clients were avid professional Futures traders and this is where I learned about trading Futures. Writing software gave me the understanding of why so many professional day traders, no longer trade the stock market. At Shadowtraders, we write Futures Market software with built in Futures trading strategies, offer an online self paced Futures trading course, deliver Futures Market Seminars, and offer a daily Chatroom where we watch the Futures Market real time. We have even delivered seminars inside the Chicago Mercantile Exchange (CME) where they trade Futures.
For those of you unfamiliar with trading Futures, we’ll start at the beginning. For those of you well versed in trading Futures, hang tight … you may just hear something new. The first question I get asked over and over is, “So what’s the Futures Market and why would I want to trade it?”
Wikipedia states that “A Futures Market is a financial exchange where people can trade Futures Contracts.” And a Futures Contract is “a legally binding agreement to buy specified quantities of commodities or financial instruments at a specified price with delivery set at a specified time in the future.”
Let’s look at the word “Contract”. That is the most critical differentiation between the Stock Market and the Futures. The Stock Market trades shares but the Futures Market trades contracts. When trading Futures, you are not actually purchasing a “small part of a company”. A Futures Contract is an agreement between a buyer and seller to trade a commodity, a currency, or an equity financial instrument, such as bushels of wheat or corn.
It is easy to understand how commodities Futures Contracts work. An airline, for example, contracts for 100,000 gallons of fuel for their planes at a certain price today, but does not take delivery until sometime next year.
Southwest Airlines was able to survive well when crude oil was trading at $140/barrel, while the other airlines were having difficulty. They purchased crude oil Futures Contracts with the oil companies years earlier when the oil was cheap, but delayed delivery until 2007-2008. When the price of oil is cheap again, they will arrange for new Futures Contracts to be delivered in future years.
Making Futures Contracts for crude oil is not trading, so you say.
In every Futures Contract transaction, there is a degree of risk. Futures Contracts are all about leveraging risk against the value of the underlying asset you want to buy.
Southwest accepted risk. They knew that the price of crude oil could potentially fall below the price they were paying. In this case they would have paid over and above what they would have needed to). Yet Southwest was able to reduce their risk because they expected oil to go higher than their contract price. Southwest was right and the leverage worked.
For the oil companies, they reduced the risk, believing that the price of oil would fall below the contract price they negotiated with Southwest. But they acquired risk because the price of oil could rise higher than the contract (thus losing additional revenue they could have earned). In this case, the leverage was not as good as it could have been.
Hey, “I am not Southwest Airlines. I am just an individual investor. I don’t want 100,000 gallons of oil. How do I benefit from trading Futures?”
The Chicago Mercantile Exchange (CME), where most Futures contracts are traded, understands that individual investors want to trade Futures just like major corporations; individual traders want to leverage their risk. They also understand that small investors are not going to risk millions of dollars on gallons of gas contracts or bushels of wheat. So the CME decided to create a trading environment that would entice individual investors to trade Futures.
Remember, as an individual investor, you have so many exchanges available to you for trading. You can trade large cap stocks on the NYSE, tech stocks on the NASDAQ, ETFs on the AMEX, and options on the CBOT. So in order to entice individual traders to trade Futures, the CME had to create an exchange that made other exchanges pale in comparison.
The CME developed “E-mini Futures Contracts” specifically tailored to professional investors. The “e” in E-mini meant they could be traded electronically. The CME developed a trading platform for your desktop where your trades can go straight to the CME. The “mini” means that the contract is a smaller version of the Futures contract that the larger institutions now trade.
The most heavily traded CME is the S&P 500 E-mini Futures Contract. This contract trades upwards of 3million contracts daily. This E-mini is valued upon the underlying S&P 500 index, the index that represents the top 500 stocks in the NYSE. The S&P 500 index is a price-weighted index. This means that the larger companies have more “weight” or “pull” than the smaller companies and are able to move the value of the index higher or lower. However…you cannot trade an index.
But you believed that Futures Contracts were limited to commodities like wheat, rice, crude, soy.
Imagine for a moment that you could trade all the top 500 stocks simultaneously. Now that would leverage risk. Should one or two stocks not do well that afternoon, you would still have 498 other stocks to trade. You wouldn’t have to pick any specific stock, nor would you have to spend hours and hours doing research on stocks either. Why? Because you would be trading all of them. Mind you, it would cost a small fortune to be able to trade 500 stocks at one time. Well, buying and selling S&P 500 E-mini Futures Contracts is just like trading all 500 stocks at the same time, for a fraction of the cost.
So how did the CME entice traders to trade E-mini’s? Check out the advantages of trading E-mini Futures Contracts. You’ll quickly see why many professional day traders gave up trading anywhere but the CME …
S&P 500 E-mini contracts are heavily traded with extreme liquidity. That means lots of volume and for you…lots of action. Lots of volume means you’ll be filled quickly often in as little as 1 second. When the S&P 500 was first traded in 1997, the average trading volume was barely 7,000 contracts / day. Now, the average is more like 2 million contracts daily with upwards of 3million not unheard of.
E-minis are electronically traded. There are no Market Makers, unlike the NYSE, who might refuse to fill your trade. The CME book is strictly first in first out (FIFO), helping make trading the CME a level playing field for all traders, institutions and individuals alike, even if you are only trading 1 contract.
Commissions for E-mini Futures is based upon “Round Trip” instead of in-and-out.
The difference between the Bid price (the highest price that a buyer is willing to pay for a contract) and the Ask price (the lowest price that a seller is willing to sell a contract for) is just one “Tick” on the CME.
(The minimum price movement between the Bid and Ask is known as a Tick. The S&P 500 trades in 25 cent increments. 1 Tick = 25 cents. 4 ticks = 1 point. If you gain 1 tick in your trade, the reward is $12.50, with 4 ticks = $50.)
A 1 tick — Bid / Ask spread can be very different than the Stock Market. With Market Makers on the NYSE, often the Bid/Ask spread can be more than 1 penny, especially if the Market Maker makes his living on the spread alone.
With trading E-mini Futures, you’ll only need to watch 1 chart, 1 instrument, the same chart, day in and day out. Could you become a truly successful trader if you monitored the same chart every day?
Stock traders usually have to watch several stocks at the same time. Watching multiple charts means flipping the charts back and forth for in case you miss something.
There is no need to do nightly research. You’re trading all 500 stocks at the same time. You won’t be researching this or that stock, worrying about whisper numbers, quarterly reporting, pre-announcements, or accounting minefields.
Traders who trade options must handle 4 conditions to be successful: underlying price, strike price, volatility, and time decay. These traders might be right but lose on their trade because they were wrong about time, the option expiring worthless before they could profit. Futures traders need only worry about 2 conditions: an advancing or a declining market. Time decay is not something Futures traders need have any concern with.
Margins are very attractive for Futures traders. 1 S&P 500 E-mini contract can be traded for as little as $400 on margin. To trade stocks, minimumly you would need to buy a 100 share lot. The average stock is $25/share, or $2500 just to get in the door.
Here’s a huge difference. The SEC defines a day trade as a transaction that opened and closed within the same trading day. A “pattern day trader” is anyone who executes 4 or more day trades within a 5 day period. To day trade, you must have in your brokerage account at least $25,000 (or your account will be frozen for 90 days if you are caught day trading).
Day trading Futures does not have such rules. Your brokerage account requires much less capital. You can open your Futures brokerage account with just $2,500. This enables even small investors to trade Futures.
You can trade the E-mini futures long (where you expect the contracts to appreciate) but you can also trade the futures short (where you expect the contracts to depreciate). In the past, bans have been placed on short selling financial stocks, on naked short selling the 1,000 top stocks, on short selling stocks that are less than $5, etc. No bans are placed on short selling Futures contracts.
No restrictions on short selling e-mini Futures Contracts? Because Futures are contracts, not shares of a particular company. As traders, taking full advantage of the Market’s volatility is essential. Not being able to short means that half of trading is lost. Always trading long means a long wait for the Market to swing up in order to enter a trade. Those days when the Market is down 200 or more points……that may be a long wait.
Trading short is especially important with the current Bear Market. There are sharp up and down moves in the S&P, DOW, and NASDAQ, perhaps more so than ever before, giving traders ample opportunities throughout the day to profit. Now is not the time to be stopped by Short selling restrictions.
When Futures trading with an IRA or 401k account, you won’t need to wait for the trade to settle 3 or 4 days before you can use that same money for the next trade. One second after you exit your trade, that same money is now available for another trade. When trading stocks, exit a trade and you may wait as long as 3 days for your money to settle prior to using that money to trade with again.
Tax rules originally intended for commodity trades also apply to E-mini Futures traders. There is a 60/40 split on taxes: 60% of your trade is long term (15% tax bracket) and 40% of your trade is short term (28% tax bracket). Let’s compare to trading stocks. Hold a stock for under 1 year, it is a short term trade. Only if the stock is held for over a year does the trade qualify for long term capital gains. With Futures, all your trading is divided by the 60/40 rule, even when your average trade is 1 minute long.
At year end, you’ll receive a 1099-B statement from your Futures broker, with only 1 figure, a net number of all your trading, not each individual trade. If you profited by $50,000, the 1099-b only shows $50,000. You can now claim $30,000 as long term capital gains and $20,000 as short term, the 60/40 split.
Doing your taxes is much easier. Since your broker gives you the net entry, you will make just 1 entry on your tax return. If you trade stocks, you are required to identify every trade you made. If you are a day trader and trade multiple stocks, it can take hours to enter all those transactions. With Futures trading, you are done in a jiffy.
You’ll find that trading Futures is nearly a 24 hour a day activity, 5 1/2 days a week. Saturday is the only day “bad” trading day for Futures — you can’t trade at all. Many stocks can’t trade pre-Market, and those that do tend to be traded very lightly. Conversely, the S&P 500 E-mini is traded world-wide and depending upon the time of day, quite heavy even pre-Market. At 2:00am EST, the Japanese begin trading the S&P 500 E-mini. At 4:00am EST, the Europeans start trading. Should you have insomnia that get you up at night, E-mini trading is definitely something for you to look into.
There is only 1 exchange/1 book for E-mini Futures….the CME. That is unlike stocks that can trade on different exchanges and have different Bid/Ask prices on each exchange. For E-mini Futures contracts, there is just one price – the CME price. Large cap stocks may trade on multiple exchanges, each exchange posting a different price.
Fills are guaranteed. If the E-mini price goes through your offer, you get filled…no questions asked. This can be a major problem for individual Forex traders. You could be in a trade waiting to exit with an offer to sell. The Forex contract goes right by your price but you do not get filled. Read the fine print in your Forex Brokerage contract that says they do not guarantee fills.
The CME Clearing House is the guarantor for Futures trades to each of its clearing members, ensuring trade integrity.
Futures Contractsdo not do expire worthless, with your money rolling to the new contract. That is very different than Options that expire worthless.
Let’s say you are an individual investor. You have been monitoring the Stock Market and now you’re bullish. You want to be part of the action because you see the Market is going up.
You only have $5,000 to invest. You’ve traded shares of stocks before and you know that with just $5,000, you would be limited to trading just one or two stocks and not daytrading. You’re looking at a lot of nightly research to identify which stock to trade.
Buying a mutual fund so you could be part of more than one or two stock moves would work. Unfortunately, given upfront load fees, your $5000 investment wouldn’t go far. Instead you can trade S&P 500 E-mini Futures Contracts. With $5,000, this could give you 5 contracts to trade ($2,000 – Note — never put all the money in your portfolio in 1 trade). Make 4 ticks a day, that will give you about $170-180/day after commissions, or $3,500 per month, $42,000 for the year. After adjusting for losses, you net $30,000….on your $2,000 investment! That equates to a gain of 1700% annually. Put the $5,000 in the bank and earn 3%, you’d make $150/year. In one day you would have gotten more than the amount the bank would give you in interest for the entire year.
The S&P 500 E-mini is not the only future you can trade once you figure out how to trade Futures. The CME’s trading platform is called Globex and there are literally dozens of Futures Contracts that can be traded on Globex now. You can trade commodities, currency futures, treasury bonds. You’ll find Futures Contracts for all of those. There are E-mini’s for the DOW, the NASDAQ, and the Midcaps.
We’ve just touched upon trading Futures Contracts…there is so much more information to be covered. This is just an introduction.
Before buying any trading education online, make sure you attend Shadowtraders’ excellent free Webinar on trading the Futures Market with Self Paced Futures Trading Course, and Futures Trading Strategies
