My name is Barbara Cohen and I am a Futures Trader – more specifically a Futures daytrader. I am the CIO of Shadowtraders.com. I first made my living off of trading 10 years ago from the viewpoint of a computer programmer, writing software for automated black boxes. Along the way, I learned about trading Futures, and why so many professional traders, especially daytraders, don’t trade the stock market any longer. Now I only trade the Futures Market. I write Futures Market software that has real time Futures Market strategies and alerts. Shadowtraders delivers an online Futures trading course that the client can do at their own pace 24/7. We also deliver Futures Market Seminars and have delivered the seminars on electronic trading 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 defines the Futures market as “A Futures Market is a financial exchange where people can trade Futures Contracts.” Now, what is the definition of a Futures Contract? 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.”
For the moment, concentrate on the word “Contract”. What is the single most important difference between the Futures Market and the Stock Market? The Futures Market trades contracts, the Stock Market trades shares. Trading Futures, you do not purchase a “piece of a company”. A Futures Contract is an agreement between a buyer and seller to trade a financial instrument, commodity, or a currency, such as barrels of crude oil or bushels of wheat.
You can understand trading Futures Contracts commodities. An chocolate manufacturer, for example, creates a contract for 2 tons of cocoa beans at the Market price today, but does not take delivery of the beans until the following year.
How did Southwest Airlines do so well when crude oil was trading at $ 140/barrel? The other airlines had grave difficulty in surviving. Southwest was clever and arranged for crude oil Futures Contracts years earlier while crude oil was cheap. They delayed delivery until 2007-2008. I’ll bet when the price of oil is cheap again, they will make new Futures Contracts for future delivery.
Arranging Futures Contracts for airlines is not trading you say.
Any Contract to trade Futures involves some risk, and leveraging that risk against the value of the underlying asset in question.
Southwest took on some risk. The price of crude could fall well below the current price they paid (so they would have paid more than they would have needed to). Yet simultaneously, Southwest reduced their risk because they figured that oil would go higher than their contract price. In the case of Southwest, the leverage worked.
Conversely, the oil companies reduced risk, believing that crude would fall below the contract price they contracted with Southwest. Simultaneously, they acquired risk…the price of oil potentially could rise higher than their contract and they would lose additional revenue they could have been theirs). In the case of the oil companies, the leverage was not as good as it might have been.
But “I’m not Southwest Airlines, I am an individual investor. I don’t want to buy 100,000 gallons of oil. How do I trade 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 created “E-mini Futures Contracts” specifically tailored to individual investors. The “e” in E-mini meant they are traded electronically. The CME gives you a trading platform for your desktop where your trades go straight to the CME. The “mini” means that the contract is a smaller version of the exact same contract that the larger institutions 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.
Say you were able to trade all the top 500 stocks on the NYSE at once. Now that’s leveraging risk If two stocks did not do so well, you would still have positions in 498 other stocks. You wouldn’t be picking any one stock. You wouldn’t be spending hours researching specific stocks. You could trade all of them simultaneously. Of course, it would cost a huge fortune to trade 500 stocks. Think of buying and selling S&P 500 E-mini Futures Contracts is as if you were trading all 500 stocks at once, for a much smaller amount.
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 …
The S&P 500 E-mini contract is extremely liquid – which means that it has lots of volume, and a lot of action. A lot of volume means you can enter and exit very quickly, in as little as 1 second. When trading first began in 1997, the E-mini contract trading volume averaged 7,000 contracts / day. Today, it is not uncommon to see 3-4 million contracts trading daily.
E-minis are traded electronically, without Market Makers, unlike the NYSE. Market Makers might refuse to fill your trade. The CME book is first in first out (FIFO). That helps make trading the CME a level playing field for all traders, institutions and individuals alike, regardless if you are trading 1 contract or 100.
Commissions for E-mini Futures is based upon “Round Trip” instead of in-and-out.
The difference between the Ask price (the lowest price that a seller will sell a contract for) and the Bid price (the highest price that a buyer will pay for a contract) is one “Tick” (one price movement) on the CME. That is like 1 penny when trading stocks. That is not always the case when trading stocks.
(The minimum price difference in trading Futures between the Bid and Ask is known as a Tick. The S&P 500 E-Mini trades in 25 cent increments. 1 Tick = 25 cents. 4 ticks = 1 point. If you profit by 1 tick in your trade, the result is $ 12.50, 4 ticks = $ 50.)
Let’s look at a 1 tick — Bid / Ask spread. With Market Makers, the difference between the Bid and Ask can be more than 1 penny, especially when the Market Maker is making his living on the spread.
When you are trading E-mini Futures Contracts, it means you’ll only need to monitor 1 chart, the same chart, each day, day in and day out. Could you become a really consistent trader if you watched the same chart every day?
Stock traders watch several stock charts simultaneously, flipping the charts back and forth for in case you miss the action.
There is basically no research to do every evening. Remember, you’re trading all “500 stocks at once.” You won’t have to research this stock and that stock, worrying about pre-announcements, quarterly reporting, whisper numbers, and accounting minefields.
For Options Traders, they must be ready to deal with 4 unique conditions to be consistent: underlying price, strike price, volatility, and time decay. Traders could be correct but still have losses on their trades because they were incorrect about time. The option expired worthless before profit could be realized. Futures traders worry about 2 conditions: an advancing market or a declining market. Time decay is unimportant to Futures traders.
Margins are very favorable to Futures traders. You can trade 1 S&P 500 E-mini contract for as little as $ 400 / contract on margin. To trade stocks, at a minimum you’ll need to buy a lot of 100 shares. An average stock is $ 25/share, or $ 2500 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 (expecting the contracts to go up) but you can also trade the futures short (expecting the contracts to go down). There have been bans placed on short selling financial stocks, bans on naked short selling including the 1,000 top stocks, bans on short selling stocks that are less than $ 5, etc. There are no bans on short selling Futures contracts.
There are no restrictions on short selling e-mini Futures Contracts. Why? Because these are contracts, not shares of a particular stock. As traders, we want to take full advantage of the Market’s volatility. If we cannot short, then half of trading is lost to us. We have to wait until the Market swings back up in order to enter a trade. On days when the Market is down 200 points, hmmmm…… that might 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.
You won’t need to wait for the trade to settle 2 to 3 days before you can use that money again for the next trade when Futures trading with an IRA or 401k account. As soon as you exit your trade, that same money is available for another trade. Trade stocks, exit a trade, and you may wait as long as 3 days for your money to settle in order to use that money again.
Because we are trading Futures, rules that were originally intended for commodity trades also apply to E-mini Futures trades. There is a 60/40 split on taxes: 60% of your trade is considered long term (15% tax bracket) and 40% of your trade is considered short term (28% tax bracket). Compare this to stocks. If you hold stock less than 1 year, it is considered a short term trade. You must hold the stock for over a year in order to qualify for long term capital gains. With Futures, all your trading is broken down by the 60/40 rule, even if your average trade is 2 minutes.
At the end of the year, your Futures broker will send you a 1099-b. This is a 1 liner, a net number of all your trading, not each individual trade. Say you made $ 50,000. The 1099-b will show $ 50,000. That is all it shows. Now you can claim $ 30,000 as long term capital gains and $ 20,000 as short term (60/40 split).
Doing your taxes becomes that much easier. You make just 1 entry on your tax return. Trading stocks, you need to itemize every trade you made. If you are a daytrader and trade a lot of stocks, it requires hours to enter all your trades. With Futures trading, you are done quickly.
Futures trade virtually 24/6. The only day you cannot trade Futures is Saturday. Many stocks do not trade off hours, and if they do, it is very light trading. The S&P 500 e-mini is traded all over the world. Depending upon the time of day, we can see heavy trading on the e-mini. For example, at 2:00am EST, the Japanese trade the e-mini. At 5:00am EST, the Europeans trade the e-mini. If you have insomnia or cats that get you up in the middle of the night to go out, e-mini trading is definitely for you.
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.
Futures Trading fills are guaranteed. If the price of the E-mini goes through your bid or ask, you get filled…no questions asked. This is often a problem for Forex traders, where you could be in a position waiting to exit with your offer to sell. The Forex current price goes right by your price but you do not get filled. Go read the fine print in your Forex Brokerage agreement that says they do not guarantee fills.
The CME Clearing House for trades is the guarantor to each of its clearing members and ensures 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.
To wrap it up, say you are an individual investor. You have been watching the Stock Market lately and now you’re bullish. You want to get into the action because you see the Market is coming back up.
You are limited to just an investment of $ 5,000. Trading shares of stock, you know that with just $ 5,000, you could only trade one or two stocks and not daytrading. Now you need to look at doing a lot of nightly research to figure out 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.
And once you get into trading Futures, the S&P 500 E-mini is not the only future you can trade. The CME’s trading platform is called Globex. There are dozens of Futures Contracts available on Globex today. Want to trade gold, crude oil or gasoline? You’ll find an e-mini contract for each of those. There are e-mini’s for the NASDAQ, the DOW, or the Midcaps. And as your abilities improve, you can trade the commodities (corn, wheat, sugar, etc.).
We’ve just touched upon trading Futures Contracts…there is so much more information to be covered. This is just an introduction.
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