Why do the Pros Daytrade Futures?
The Powerful Advantages of Trading the E-Mini S&P 500 Futures over Stocks, ETFs and Forex
Craig Ross, ApexFutures.com
Have you ever wondered about the approach used by those who succeed in trading? Why some traders prefer futures over equities and/or Forex? If your answer is “yes” and you are interested in daytrading this is definitely an article you should take a minute to read. The following 18 points demonstrate the particular advantages of daytrading the E-mini S&P 500 over trading stocks, Forex and ETFs like the SPDRs and QQQs.
1. Efficient Market
During normal market hours the Emini S&P 500 (ES) futures has a tight bid-offer spread of typically 1 tick or $12.50 per contract. With a current contract value of about $50,000, that comes out to .025% of the contract value, which is one of the best spreads in the trading world. This spread should be considered your cost of entry (not unlike commissions) to enter and exit the market. The wider the spread, the more the trade has to move in your favor just for you to get to break-even.
Depending on the stock or currency pair you are trading the bid-offer spread may be much wider. Also, since Forex firms “create” the market and therefore, the bid-offer spread, they can widen it to whatever they see fit. Even when most Forex firms advertise a fixed spread, they typically reserve the right to widen when they see fit.
2. Central Regulated Exchange
All ES trades are done through the Chicago Mercantile Exchange and its member firms where all trades are recorded. All trades are made available to the public on a first come first served basis and trades must follow the CME Clearing rules, along with the strict CFTC and NFA rules.
Forex trades occur “over the counter,” (off any exchange floor or computer) where there is no centralized exchange with a time and sales report to compare your fill. Different traders with different firms can experience different fills even when trades are executed simultaneously. Even more alarming is that in most cases the Forex brokerage firm you have an account with takes the other side of your trade and is therefore “betting” against you. Even for equity trades many stock brokerage firms direct your trades to brokers that give them a “haircut” or kickback for your order. Again, this can become a conflict of interest since your order may not be getting the best possible execution.
3. Low Commissions
ES commissions and exchange fees are only about $2.00 per contract and larger traders can lease a membership to further reduce fees. This low transaction cost allows daytraders to get in and out of the market without commissions significantly cutting into their profits.
While most Forex firms do not charge a “disclosed” commission, they make their money by creating their own bid/offer spread and taking the other side of your trade, typically costing much more than the transaction costs of the ES. The average discount stock brokerage firm charges $5-10 per trade, which can really eat into your potential daytrading profits.
4. Level II Trading
You can see the 10 best bids and 10 best offers along with their volume in real time and allow the placement of your order at any price you wish when trading the ES. This transparency of the market’s orders allows ES traders to see where and how many orders have been placed ahead of them. For short term daytraders this information me be very valuable and may be used as an indication of future market movements.
Some Forex platforms show Level II type pricing, however, since there is no centralized market it is only the orders that that firm has access to and not the entire market. Also, most Forex firms do not allow you to place an order within a few ticks of the last price or between their posted bid/offer spreads.
5. Virtually 24 Hour Trading
The ES futures market is open from Sunday night at 5p CST until Friday afternoon at 3:15p (it closes from 3:15p-3:30p and also closes daily from 4:30-5p for maintenance). This allows you to enter, exit or have orders working to protect your positions almost all day long, even while you sleep.
Even with pre and post market trading, the stock market is open less than 12 hours per day, and the liquidity during these sessions are not always good.
6. All Electronic Trading
There is no trading pit for the ES which means there are no market makers, no locals and no floor brokers, since all orders are matched by a computer on a first come-first served basis no matter how large or small they are. This means all traders see the same level II market and bid/offer spreads with an equal chance to hit them.
While most Forex firms offer electronic trading, many manually approve each order at a trading desk because they are market makers against your orders. Many times larger traders are given preferential treatment and better bid/offer spreads.
7. Leverage
Of course more leverage is a double edged sword since higher leverage equates to higher risk, but one Emini S&P contract currently has an approximate value of $50,000 and can be daytrade for as little as $500 which is 1% of its total value. Even if you hold a position overnight, the current overnight margin is only $6,188 which is still only about 12%.
Not all stocks and ETFs are available to be traded on margin, and the ones that can require at least 50% margin to do so.
8. No Interest Charges
For futures trading the daytrade and position margins do not require you to pay any interest on the remainder of the funds. The $500 posted for daytraders is a performance bond and traders do not pay interest on the remaining value of the ES futures contract. No special type of futures trading account is required to be able to take advantage of the daytrade margins.
Stock traders typically must apply for a special account in order to be able to daytrade and/or trade on margin and for those who can use the 50% margin they need to pay interest on the other 50% they are borrowing. Forex has a cost of carry associated with its trading which means interest may be charged or paid on positions taken, but in the end this interest is seen as a revenue stream for forex brokers and works to their advantage.
9. No Pattern Day Trader Rule
Futures daytrade accounts can be opened with as little as $2,000 and do not have any Pattern Daytrader Rules associated with them. Of course, like with all trading, only risk capital should be used no matter what the amount you choose to start with.
The SEC describes a trader who executes 4 or more daytrades in 5 business days, provided the number of daytrades are more than six percent of the customer's total trading activity for that same five-day period as a Pattern Daytrader. As a Pattern Daytrader you are required to have a minimum of $25,000 starting capital and cannot fall below this amount.
10. Liquidity
The Emini S&P futures trade an average of over 2,000,000 times a day which allows for great price action, volatility and speedy execution.
Not all stocks and forex markets are as liquid which means movements can be shaky and erratic, making daytrading more difficult.
11. Tax Advantages
Futures traders have favorable tax consequences for short term traders, since Futures are taxed 60/40, which means that 60% of the gain is taxed at the maximum rate of 15% (similar to long-term gains) and the other 40% is taxed at a maximum rate of 35% as ordinary income.
Securities positions held for less than 12 months are considered short term gains and taxed at 35%. Of course everyone’s tax situation is different and should consult a licensed accountant for their specific situation.
12. Diversification
When trading a stock index like the Emini S&P your “news risk” is spread out over the entire market. Should a report or rumor come out on an individual stock it should have very little impact on the whole index you are trading.
When you take a position in an individual stock you may be susceptible to stock specific risk which can occur without warning and with violent effects.
13. Safety of Funds
When you trade the ES you are trading with a Commodity Futures Trading Commission (CFTC) regulated and National Futures Association (NFA) member firm which is subject to the customer funds rules laid out by the US government. In the over 100 years of futures trading there has never been a loss of customer funds due to the failure of a clearing member because of these rules that are in place. While there are never any guarantees that you can’t lose money, this track record is unprecedented.
Many forex firms are unregulated and therefore there is no protection of customer monies. Even with regulated forex firms, funds are not considered segregated, so if a regulated firm goes bankrupt clients funds are not offered the same protections as they are in the futures market.
14. Focus
Many ES futures traders only track the ES market and find it is the only chart they need to follow. There are always opportunities and great volume throughout the trading day. When large institutions or traders want to take a position in the market or hedge a portfolio they usually turn to the futures markets to get this done quickly and efficiently. Therefore, why not trade the market the “Big Boys” trade?
Most traders agree that individual stocks and, therefore, the market as a whole follows the futures indices, and not the opposite. As a stock or forex trader you may need to scan dozens of stocks or currency pairs for opportunities. Many times specific stocks fall out of favor so volume and, therefore opportunities dry up and traders are forced to find a new stock to trade.
15. Easy to Go Short
There are no rules against going short the ES and it is just as easy as going long. Traders simply sell short the ES contract in hopes of buying it back later at a lower price.
Most stockbrokers require a special account with higher requirements for you to be able to go short. Some stocks are not shortable, or have limited shares that can be shorted. Also, up-tick rules could be re-enforced and the government has put temporary bans on stocks that can be shorted.
16. Direct Correlation
On average the ES futures are directly correlated (although not perfectly) to the underlying S&P 500 index in the short and long term.
Double or triple weighted ETFs do not track the S&P accurately over longer periods, and some currency ETFs have credit risks associated with them.
17. Deep Market
The S&P 500 index is comprised of very actively traded stocks with some of the largest market capitalizations and with hundreds of billions of dollars invested in some fashion in them. With such large dollar values and high trading volume it would be very hard to manipulate its movements.
On the other hand sometimes it is easy to move or even manipulate a particular stock and even in a foreign currency market. George Soros has been accused of intentional driving down the price of the British Pound and the currencies of Thailand and Malaysia and many stock “promoters,” insiders and markets makers have been convicted of manipulating stocks.
18. Big Players
The old adages, follow the “big boys” and “smart money” are usually true when it comes to trading, and large money managers, pension funds, institutional traders, etc. tend to be very active traders in the futures markets. The S&P 500 futures contract is generally recognized as the leading indicator for the underlying stock market movements.
Most active equity traders admit they first look to the index futures for an indication of what the stock they are trading might be doing, so why not just trade the leader of the market, the ES futures?
Trading is hard enough so why choose a market where the odds are stacked more against you before you even place your first trade. The above mentioned 18 points clearly make the E-Mini S&P 500 futures the best choice for daytraders and will give you the most bang for your buck.
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