Why I am Relying More on Index Futures Trading

Sep 24, 2007: 11:24 AM CST

Part of being a trader is evolving not only as the market changes, but as you change and learn new information and assimilate that information into what you already know.

I’ve shied away from trading futures heavily, because of a lack of experience or comfort with that market, compared to my years of knowledge about the stock market.

However, the futures market offers certain benefits  within stark similarities that no stock or no ETF can offer, and so I’ve been increasing my index futures trading recently, and wanted to share what I’ve learned so far.

I suspect a majority of traders who trade index futures trade the S&P 500, or e-Mini (@ES) contract. I don’t. I don’t like or understand the price structure yet on the contract. I also do not trade the @NQ (Nasdaq mini) for the same reason. Perhaps I’ll shift in the future, but what makes sense to me logically and price structurally is the Dow-Mini (@YM).

Let’s look at these:

The S&P 500 ‘e-mini’ (@ES) contract trades in quarter-point increments, where each ‘tick’ is worth $12.50 per contract. A full S&P point is worth $50.

The Nasdaq 100 ‘e-mini’ (@NQ) contract also trades in quarter-point increments, where each ‘tick’ is worth $5.00. A full ‘Nasdaq” point is worth $20.

The Dow 30 ‘e-mini’ (@YM) contract trades in single-point increments, where each ‘tick’ is worth $5. A full Dow Point is worth $5. Ten Dow points are worth $50.

Of course, there are other contracts, including a full Dow contract ($25 per point/tick) and other S&P/NASDAQ contracts, but we will stick with discussing the ‘minis’ here.

To me and I speak only for myself the Dow pricing structure makes sense most intuitively for me. Hence, I am building experience and familiarity first with the Dow and then to other contracts. It’s easier to me to calculate intuitively the value of a position when it’s “in terms of the Dow futures.” For the rest of the article, I will speak in terms of “Dow e-Mini Futures” but realize that what I say applies to the other Index Futures contracts as well

Unique Benefits

The first benefit is that futures trade 23 hours per day. It’s not fair to assume that the volume, interest, chart patterns, and indicators WORK 24-hours a day because they don’t. The patterns and price action are most robust during normal market hours and slightly beyond. However, if something major happened after the stock market has closed, you can offset or add to your existing futures position whenever you wish.

The second benefit is that futures contracts are  by nature  ‘marked to market’ and enjoy favorable tax treatment. While a specific discussion is beyond my scope here, just know that any profits you make as a futures trader will be treated differently than if the same profit was earned in stocks or even similar ETFs (such as the DIA, QQQQ, or SPY). Specifically, futures profits receive “60/40″ treatment, where 60% of the profit is taxed at ‘long term capital appreciation’ which currently stands at 15%, and the other 40% is taxed as ordinary income, which can be greater than 33%. This simple benefit can save thousands of dollars a year in taxes over ETFs.

The third benefit is fluidity and liquidity. Now, few can argue that the major US market ETFs are not liquid, but often major futures contracts  especially when trading smaller size  are extremely liquid with a minimum of slippage. If you save even a penny (or more) of slippage in the futures vs ETFs per trade, then that as well can add up to hundreds or thousands of dollars per year.

The fourth benefit and danger  is leverage.

Leverage:

Leverage deserves its own section. Again, I will speak only in terms of the Dow e-mini Contract.

One @YM contract is (in essence) equal to 500 shares of the Dow Jones EFT (DIA).

Because the @YM contract is 5 times the value of the Dow Jones Industrial Average, the current monetary value of a @YM contract is (approximately) 13,850 x 5 = $69,250.

People who begin futures trading might balk at this point. One contract currently controls approximately $70,000.

For an ETF trade in the DIA, it would require $70,000 to take on 500 shares which you can do on margin if your account is less than $70,000.

But how much do you need in your futures account to control $70,000 of ’stock’? Less than $3,000! This depends on your broker, but that is the approximate value.

Needless to say, if you are in a losing position, your account can be shattered quickly, because you are in essence trading 23 times your initial ‘position’.

Commissions

A final point is that at least for my accounts at TradeStation commissions are half of what they would be for a round-trip trade.

A @YM trade costs approximately $2.50 to enter and $2.50 to exit. That’s a total commission of about $5.00 to control 500 ’shares’.

The subsequent position of 500 shares of the DIA ETF would be at TradeStation’s rate of $1 per 100 shares – $5.00 to enter and $5.00 to exit.

If you traded only the DIA for one year, and then only the @YM the next year, assuming all things are equal, you would save HALF of your bottom line on commissions for the year you traded futures.

Ever wanted to cut your commissions in half?

Conclusion

This isn’t intended to be a full report on futures trading. Futures trading involves specific risks that stock trading does not.

Futures trading is not for everyone, and is probably not for beginners, but experienced stock traders can benefit from studying the futures markets if they are mainly Index ETF traders.

Futures contracts are greater leveraged, (often) cost less in commissions, result many times in less slippage, and are treated more favorably than stocks.

If you haven’t considered futures trading, it’s worth studying.

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Comments
  • Futures trading is very similar to spot trading. It's just with some of the products you can trade only futures. Take oil for example, unless you really want to deliver it you should trade futures.
    Best time to trade oil? Wednesday when US announce weekly oil investory. Great swings.

  • Hey Tom,

    There are so many advantages to index futures trading over regular ETF trading PROVIDED that you have proven to yourself that you can make money with a consistent approach/strategy in trading the regular ETFs. There's not that much difference in terms of price patterns, though there absolutely will be some variance.

    Basically, you'll (most likely) save on commissions (sometimes 1/2 the cost of an ETF round-trip trade), taxes (a majorly overlooked area), slippage (rarely will you 'slip' on futures), and leverage (this is where it gets dangerous and differs the most from ETF trading).

    With a leveraged ETF, the most (correct me if I'm wrong) you get is 2x the index. One Dow-Mini contract (@YM) is equivalent of 500 DIA shares. To control that amount, you need to put up $3,500 to $4,000 and that's it (compared with $70,000 to control 500 DIA shares).

    You seem to have a valid method, and I use many of those features. Programming it is the difficult part. You really need discretion when trading index futures, if for anything then regarding the principles of confirmation/non-confirmation with the TICK, TRIN, breadth, other indexes, other futures contracts, pending news reports, etc. I personally can't envision myself trading mechanically - it's just not me but it works great for some people.

    I use TradeStation to backtest ideas, but I really haven't done strategy automation with them. They're probably #1 in terms of strategy automation in terms of platforms for retail traders so I give them my 100% approval for you.

    I don't want to recommend too many resources because there's so much good information out there and I don't want to feel like I've excluded anyone or any company or blog.

    Suffice it to say that you should avoid any service/blog that claims they make tens of thousands of dollars a day and that you can too. Avoid anyone who proclaims that they have a 90% win-rate.

    There really is a lot of information out there, and it's best to find a match between what the site teaches/trades and how you approach/trade the markets.

    If I can be of further help, please let me know.

  • Tom

    Hi Corey,

    Great post.

    I want to learn more about index futures (e-mini) trading. I currently trade QQQQ with leverage through QID and QLD. I am very interested to learn more about the pros/cons of trading the E-minis vs. index ETFs and which strategies to consider. Are there any good blogs or books you recommend?

    My current methodology involves using DMAC and basic price pattern recognition along with pivot points/support resistance and trendlines to establish entries/exits. I have found this approach to be profitable but it lends itself to a mechanical/automated approach rather than discretionary. I am curious what you think of Tradestation's automation features (EasyLanguage).

    Tom

  • JKW,

    Thank you for the comment! In TradeStation, I'm going to start turning off the 24-hour chart set-up, which essentially eliminates any overnight data. I'll still include the 1-hour pre-market open for each day (because I feel that is valuable information). I sometimes like to see the overnight data, but feel that constantly viewing it - and the calculation (indicator and MA) 'errors' that result - aren't worth the benefit.

    I'll be going back and adjusting my desktops/workspaces to reflect this change and already I am liking the results. In regards to TradeStation, it has a very large and active developer community that are often willing to take suggestions and create new code as needed, which is often offered free on the forums.

    Corey

  • jkw

    If you don't want the moving averages to include the overnight period, you could calculate them yourself. Both EMAs and SMAs have very simple formulas that you could easily program with almost no programming experience. You could also ask for it as a feature request for your platform. There are probably enough people that would benefit from having regular trading hours only for indicator calculations that they would be willing to implement it.

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