Thursday, April 7, 2011

Introduction to Emini Futures Trading

If you are unaccustomed to trading Futures, we'll start at the beginning. If you are Futures trading, hang on ... you could just hear something you didn't understand.

The first thing I get asked over and over is, "So what's the Futures Market and why would I want to trade it?, here's the Wikipedia answer: "A Futures Market is a financial exchange where people can trade Futures Contracts." OK, sure. But exactly what is 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."

Notice the word "Contract". The first significant departure between the Futures Market and, for example, the Stock Market is that the Futures Market negotiates contracts, not shares. You are not owning a "share (or small section) of a company". A Futures Contract is an irrevocable agreement between two traders to trade an exact amount of a distinct commodity or financial instrument, eg, bushels of wheat or gallons of gas.

It is simple to understand how commodities Futures Contracts trade. A bread manufacturer, for example, drafts a contract for 5,000 bushels of wheat at the today's current price, but defers delivery of the wheat for a few months.

That was in what way Southwest Airlines thrived when the price of fuel was $140/barrel and different airlines were having difficulties. They had acquired Futures Contracts with a variety of oil stocks years before, when the oil price was cheap, but waited for shipment until 2007-2008. As the oil price is cheap again, they'll be purchasing Futures Contracts for transfer in 2011-2012.

Negotiating Futures Contracts for oil, as an example, is not trading, you want to say.

In Futures Contract transaction, there is a measure of risk. Futures Contracts are all about leveraging risk versus the expected value of the underlying asset one wants to buy.

Southwest acquired risk in that the cost of crude could fall below the price they actually paid (so they end up paying over what they would have needed to). Simultaneously, they reduced their uncertainty as they thought (and they were correct) that the oil price would appreciate than their original contract price. In their case, the gamble was successful.

Conversely, the oil companies reduced chance, believing that crude would go below the contract price they contracted with Southwest. Simultaneously, they acquired uncertainty...the crude price potentially could go higher than their bargained contract and they might lose more income they might have been for them). For the oil companies, the risk was not as good as it might have been.

Hmmm you say, "I'm not Southwest Airlines. I am an individual buyer . I don't want to purchase 200,000 gallons of crude. How can I invest in Futures?"

The Chicago Mercantile Exchange (CME), which is where nearly all Futures contracts are traded, understands that small investors want to invest in Futures just like large companies; small traders want to leverage their risk. The CME also realizes that small traders are not going to risk thousands of dollars on gallons of crude contracts or bushels of wheat. In that way the CME resolved to develop a trading stomping ground that would entice individual buyers and sellers to trade Futures.

The CME knew that individual traders can trade on so many different Exchanges. They can buy and sell large cap stocks with the New York Stock Exchange,options with the CBOT,tech stocks with the NASDAQ, and ETFs with the AMEX. So veteran buyers and sellers Futures trading, the CME knew they were required to offer an Exchange that showed other Exchanges to be less advantageous to seasoned investors.

To begin, the CME built Emini Futures Contracts designed for small traders. The "E" in Emini basically means that they are traded electronically. You will have  a trading program sitting on your desktop from which your trades go directly to the CME. The "mini" indicates that the contract is a undersized version of the precise contract that the larger buyers and sellers trade.

Probably the most heavily traded CME Emini Futures Contracts is the S&P 500 Emini. This Emini is founded upon the underlying S&P 500 index that represents the top 500 stocks in the NYSE. The S&P 500 index is price-weighted. This means that many of the stocks have more "weight" or "pull" than others. Bigger investors move the value of the index up or down more than the smaller traders by trading big numbers of shares. The situation is, unfortunately, you may not trade an index.

And you only thought that Futures Contracts were just based on commodities like wheat, rice, crude, corn. They also include trading currencies and indexes.

What if you could buy and sell all the largest 500 stocks on the NYSE simultaneously. That is leveraging chance. If a couple of stocks did not do so well, you would still own shares in hundreds of other stocks. You would not have to be choosing any individual stock. You wouldn't be putting in hours locating specific stocks. You could buy and sell all of them at once. Now, it would cost a small fortune to trade 500 stocks. Investing in S&P 500 Emini Futures Contracts is like buying and selling all 500 stocks simultaneously, for a much smaller amount.

In what way did the CME get buyers and sellers to trade Emini Futures instead of stocks? Below are the major advantages of trading Emini Futures Contracts. You will quickly understand what the reason is that so many seasoned traders only trade Futures ...

S&P 500 Emini contracts are heavily bought and sold. That results in a lot of trades and for traders...lots of action. Lots of volume results in your being filled  quickly often in just 1 second. When the S&P 500 was first bought and sold in 1997, the average trading volume was not even 7,000 contracts / day. Now, the norm is more like 3 million contracts each day with as much as 4 or 5 million not unheard of.

Emini Futures are electronically traded. There are no Market Makers, which is different from the NYSE, who may just choose not to execute your investment. The CME book is first in first out (FIFO), that helps to make trading at the CME equal playing field for all buyers and sellers, institutions and individuals alike, even if you are only trading 1 contract.

Commissions for Emini Futures is priced upon "Round Trip" instead of both buy and sell.

The difference between the Bid price (the most that a buyer may pay for a contract) and the Ask price (the lowest price that a investor is willing to sell a contract for is only one "Tick" on the CME. (The difference in price between the Bid and Ask for Futures trading is known as a Tick. As an example the S&P 500 Emini trades using 25 cent increments. 1 Tick is 25 cents. 4 ticks being 1 point. If you win 1 tick with your trade, you receive back $12.50, 4 ticks = $50.)

A 1 tick -- Bid / Ask spread may be distinct from the Stock Market. With Market Makers trading at the NYSE, often the Bid/Ask spread will be over 1 penny. This is a given if the Market Maker earns his livelihood on the difference alone.

If you are trading Emini Futures Contracts, you will just have to monitor 1 chart, the the exact same chart, every day, day in and day out. Could you be a really profitable trader if you watched the same chart every day all month long?

Stock buyers and sellers generally have to watch a lot of stocks simultaneously. Monitoring results in flipping the charts back and forth so that you don't miss an opportunity.

With trading Futures you don't need to work at research at're trading all 500 stocks at the same time. You don't spend the time to do research about this stock or that stock, You do not spend the time to do investigating about quarterly reporting, whisper numbers, pre-announcements, or accounting minefields.

Options Investors should be all set to copy with 4 different conditions to be successful: underlying Market price strike price, volatility, and time decay. Buyers and Sellers could be correct but still result in losses on their investments as a result of the fact that they were not right concerning time. The option was worthless at expiration before profit could be realized. Futures Buyers and Sellers worry about 2 trading conditions: a rising Market or a declining Market. Time decay is not an enemy to Futures buyers and sellers.

This is another major change. The SEC identifies a day trade as a transaction that opened and closed during the same trading day. A "pattern daytrader" is that person who trades 4 or more daytrades in a 5-day time frame. To daytrade equities (since 9-11), traders have to have at a minimum $25,000 in your investment account (or your account probably will be stopped for 90 days, should you be found daytrading).

Day trading Futures does not have such limitations. A broker account requires far less funding at the start. A lot of Futures trading firms enable you to open an account with only $2,500. This amount opens the investment community to just individual buyers and sellers).

You can {trade Emini futures Long (if you expect the contracts to go up) but you can also trade the futures to go Short (if you expect the contracts to go down). There have recently been restrictions assigned to Short Selling financial stocks, bans on naked Short Selling that include the 1,000 top stocks, restrictions on Short Selling stocks that are less than $5, etc. There are no restrictions on Short Selling Futures contracts.

There are no bans on short selling Emini Futures Contracts because Futures are not shares of a particular company, they are contracts. For traders, it is important to take full advantage of the Market's volatile movements. Therefore not being able to short that means one half of your investing is unavailable to you. If you always have to buy and sell long means that a long wait for the Market to rise in order to enter a position . If the Market has fallen 200 or more points......that might be a long waiting time.

Trading Short is especially useful to a Bear Market where there are razor sharp up and down moves in the S&P, DOW, and NASDAQ. Giving buyers and sellers a lot of opportunities through the day to profit is vital to becoming consistent.

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 investment. One second after you exit your trade, that same money is now available for another investment. When buying and selling stocks, exit an investment made in your IRA account 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 trading also apply to Emini Futures traders. There is a 60/40 split for your tax return: 60% of your trading is long term (15% tax bracket) and 40% of your trading is short term (28% tax bracket). Let's compare to trading stocks. If you hold onto a stock for under 1 year, it is considered a short term trade. Only if the stock is owned 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 normal trading is 1 minute long. At year end, you'll get a 1099-B statement from your Futures brokerage, with only 1 figure, a net amount of all your investing, not each individual trade. If you earned $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.

Filing your tax returns is so that much simpler. You make just 1 entry on your IRS tax form. Buying and selling stocks, you are required to itemize every trade you made on your return. For daytraders who buys and sells many stocks, this requires hours to enter each and every one of your trades. With Futures buying and selling, you are done in a jiffy.

Futures investing is available round the clock 24/6. The exception to this that is a "bad" investing day for Futures is Saturday -- you can't invest. There are a lot of stocks that do not buy and sell before the Market opens, and even when they do buy and sell, investing them has very light. The S&P 500 Emini is buying and selling world-wide and depending upon the the time of day where traders live, you can experience heavy investing. At 2:00am EST, the Japanese buy and sell the S&P 500 Emini. At 4:00am EST, the Europeans start investing. If you own cats that get you up at night, Emini trading is most definitely for you.

Each Futures Contract is traded on only 1 Exchange/1 book....the CME. Stocks, on the other hand, invest on a variety of Exchanges, each Exchange showing distinct Bid/Ask prices. Emini Futures contracts only have one single price - the CME price. Bigger NYSE cap stocks trade on more than one Exchange, each Exchange can display a distinct price.

Your executions are ensured. If you are in a position, for example, and the Emini current price goes through your offer, you get filled. No problem. Fills is a major problem for smaller Forex investors. You may be in an investment hoping to exit. You want to exit. The Forex contract goes through your current price and does not fill you. Then you note in fine print on your Forex brokerage contract that they do not ensure executions.

The CME Clearing House is the guarantor for Futures investments. For each of its clearing associates, this secures investment honesty.

Futures Contracts do not expire worthless, your portfolio just goes over to the new contract. That is extremely opposite to Options that expire worthless.

For instance, say you are an individual trader and you have been watching the Stock Market. Finally you are bullish. You watch the Market running up and want to get into the action.

Unfortunately, you only have $5,000 to trade. You've bought and sold equities before and you know that with only $5,000, you must restrict your investments to just one or two stocks. That causes a a lot of research at night to identify which stocks to choose.

Purchasing a mutual fund so you may participate in over one or two stock moves would be ok. Unfortunately, given upfront load fees, your $5000 investment wouldn't go far. Instead you can invest in S&P 500 Emini Futures Contracts. Having $5,000, this could offer you 5 contracts to invest in about $2,000 (Note -- never trade all the brokerage account cash in your portfolio in 1 trade). Now make 4 ticks each day, that will give you roughly $170-180/day after commissions, or $3,500 per month, $42,000 for for the entire year. Now adjust for losses, you earn $30,000....on your $2,000 investment! That equals  a gain of 1700% each year. Keep the $5,000 in in your bank account and earn 3%, you would earn $150/year. Daily you would have profited by over the amount the bank could provide you in interest for the whole year.

And once you get into Futures trading, the S&P 500 Emini is not the sole future you can invest in. The CME's trading platform is called Globex. There are literally dozens of Futures Contracts available on Globex today. Do you want to trade silver,crude or gold? You'll find an Emini contract for each of those. There are Emini contracts for the NASDAQ, the DOW, or the Midcaps. And when your trading abilities get better, you can trade the commodities (corn, wheat, sugar, etc.).

Even though much of the data above is useful, this is the real separating trading stocks and investing in futures...Leverage.  Say for example you want to be a daytrader.  You identify a stock whose price is $25/share.  You daytrade 100 shares, or $2500.  Since you are daytrading, your brokerage will provide you intra-day margin, making your 100 shares cost you roughly $600.  Since it is a stock, the first consideration you must worry about is commission.  The cheapest commission round trip is $10.  In this way your stock must rise 11 cents in order to earn $1.  The broker grabs all the profit out of immediately.

Juxtapose that with the Futures Market.  Let's say you purchase 1 S&P 500 Emini for $500.  This is $100 less than the 100 stock shares.  Should the current Market price make 1 price movement, or 1 tick, you earn $12.50.  your net is around $8.00 (there are better commissions that are offered by the different Futures brokerages), but we'll consider the worst commission.  In the environment of investing futures, the broker may not have everything up front.

Therefore, you would have to daytrade 500 shares of stock to avoid the broker taking everything upfront.  With 500 shares, it will cost you $3125.  But with $3125, you can trade 6 S&P 500 Emini contracts.  500 shares x 10 cents (10 price movements) = $40 profit ($50 - $10 brokerage commission).  So weigh that against what you can earn in the Futures market. 10 ticks (10 price movements) x $8/contract x 6 contracts = $480 profit.  That is equal to a 15% ROI! For this reason is the reason that many professional buyers and sellers want to invest in Futures not stocks.

Sure it's a great deal of information crammed into this essay. There is so much more to go over concerning trading Emini Futures Contracts.  Here is just the start.  Go enroll yourself in a Futures Trading Course like the one offered by Shadowtraders where you will learn Futures trading strategies


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  2. your advice was amazing, great efforts by blog author providing market strategies & tips.

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