Futures Trading 3 - CBOT mini-size Dow

Why I Prefer Trading the CBOT mini-size Dow
by John Carter

Now that we have covered Futures 101, let's take a look at why I prefer to trade the CBOT mini-sized Dow (YM) over the ES or NQ, and, for that matter, individual stocks and options.

In its simplest form, the markets rise on a day-to-day basis because current demand for stocks exceeds current supply. This has nothing to do with being in a secular bear market, a cyclical bull market, high P/E ratios or Maria Bartiromo's choice of a necklace. This has everything to do with what traders are willing to pay for a stock or market today.

It doesn't matter if demand is falsely created by a hedge fund "taking the street" (buying large amounts of a single stock to drain a market maker of its inventory, forcing them to buy it back at a higher price). Or a squeeze that whacks shorts and forces them to cover, or a rumor that a biotech stock is being cornered by Martha Stewart. Demand is demand and that is what drives markets higher. The inverse is equally true: If there is too much supply in the market, prices will fall. Although supply and demand can be more difficult to measure with a single stock, it is very easy to measure with a popular index such as the DowSM. This is why I feel strongly that one of the best contracts out there to trade for both beginning and professional traders is the Chicago Board of Trade's mini-sized Dow futures contract. The specific reasons are as follows:

Bang for the Buck
For disciplined traders who use live stops, the leverage in trading CBOT mini-sized Dow futures over stocks is a huge plus.

Better Spreads than the E-mini S&P and E-mini Nasdaq
The CBOT mini-sized Dow has the same specifications as the popular E-mini S&P contract:

• 1 point in the E-mini S&P = about 10 points in the mini-sized CBOT Dow
• 1 point in the E-mini S&P = $50; 10 points in the CBOT mini-sized Dow = $50


Figure above shows movement in the Dow and S&P over the exact same time frame. The Dow has moved 13 points lower (from the high at point 1 to the low at point 2), and during this same time, the S&P has moved 1.5 points lower.

The Dow moved lower in thirteen 1 point increments. However, the S&P made a similar move in 6 quarter point increments. A quarter point on the S&P = about 2.5 points on the Dow. This is a huge different in the spread!

The key here is that a trader will get picked off on stop runs less frequently if he or she uses the CBOT mini-sized Dow over the E-mini S&P. Why is this? Again, the E-mini S&P moves 1 point in 4 quarter point increments. The CBOT mini-sized Dow will move an equivalent 10 points in ten 1 point increments, giving the trader six extra places to place a stop or target. This is a huge advantage over trading the E-mini S&P and will save a trader a lot of money over the course of a trading career. By trading the CBOT mini-sized Dow, the trader is essentially cutting the spread by 60 percent. That money goes straight into the trader's pocket. In addition, due to the spread, you will get your stops picked off more in trading the S&Ps on stops that are placed equivalently on YM. I will show specific examples of this in Section 5. The spread is even worse in the NQ. Whereas the S&Ps will move 1 point in 4 quarter point jumps, the Nasdaq will move the same 1 point in 2 half point jumps.

This goes back to what I talked about earlier in "trading the right market for your personality or trading method." My Multi-Pivot system (one of the strategies I will talk about) works good on the S&Ps, but it works great on the CBOT mini-sized Dow, because of the way the market is "built" and the way it moves.

Liquidity
Although perfect for the smaller retail trader, the CBOT mini-sized Dow has caught fire and now has the liquidity to move size, chalking up daily trading volume of well over 100,000 contracts per day. In trading, volume begets volume, and YM will continue to expand even more as traders, commodity trading advisors and managed funds take advantage of the trading advantages for this contract.



Figure above shows weekly volume growth in the CBOT mini-sized Dow since its inception.

Keeping on the Path of Least Resistance
A trader can watch the 30 stocks in the Dow to get a very good idea of how the index is acting or is going to act. I like to place all 30 Dow stocks in a window and have them automatically sorted from strongest to weakest each day on a Net % Change basis. Getting a feel for all 500 stocks in the S&P 500 at a glance is as impossible.



Figure above shows all 30 Dow Stocks sorted by the Net % change. With this I can glance at it and see that 22 out of the 30 of the stocks are red (down on the day). This filter gives me a clean, easy downward or upward bias to the market as I can watch more stocks going red, or going green, as the markets start to fall apart or try to improve.

If a trader currently is in an individual stock, he can have all kinds of outside influences move the price. Maybe insiders are dumping their own stock. Maybe an analyst has just issued an upgrade while his trading department is dumping shares off to an unsuspecting public. Maybe the company is giving positive forward guidance as its last hope to stave off bankruptcy proceedings. The factors affecting an individual stock are endless.

However, when investors in general want to sell stocks, the Dow reacts by heading south. If they want to buy, the Dow spurts green. The "Dow effect" encompasses individual investors, hedge funds, program traders and arbitrage traders. In addition, the Dow moves actively in all buy and sell programs. Supply and demand at its finest - this is what makes the CBOT mini-sized Dow futures contract such a beautiful instrument to trade. This, combined with the much tighter spreaders than the ES or NQ contract, make it the best contract to trade for intraday trading.

Now that we have covered how futures work, and why I like to trade the CBOT mini-sized Dow, section 4 will discuss why you should diversify your trading into precious metals and bonds, and then we'll start looking at my trading strategy.

Profitable Futures Trading.

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Futures Trading 2 - CBOT Introduction

Continue from Part 1 .... (by John Carter)

Key Points: How Do Futures Work?

• First off, when you buy a futures contract, you are not physically buying anything. This is simply a way to participate in the price movement of the market of your choice. If you think a market is going to move 10 points, you can buy a futures contract, long or short, and make money on the move if it goes in your direction. Also, if you own a stock index futures contract that expires, you are not going to get a bunch of stock certificates dumped on your doorstep. The expired contract will be converted to cash, and you will see the cash in your account.

• For price movement: If you have 1 contract in the E-mini S&P, and it moves 1 point (i.e., from 1032.75 to 1033.75) that translates into $50 in your profit and loss (P&L). For the E-mini Nasdaq, a 1 point move equates to $20. For the CBOT mini-sized Dow, a 1 point move is $5.00. So, if you buy 3 S&Ps, and you get 10 points, that is $50 x 10 points x 3 contracts = $1500.00. For the Nasdaq and the Dow, it is the same thing, except you would use $20 per point on the Nasdaq and $5.00 per point on the CBOT mini-sized Dow.

Figure 2.1 shows a CBOT mini-sized Dow trade with 10 contracts. In the above chart, a 27 point move in the CBOT mini-sized Dow with 10 contracts is $1350.00.
• Of course, this goes both ways so money management is the absolute key to trading futures. It is imperative that you know your stop before you start, and you stick to it no matter what. In futures trading, hoping and praying can lead to ruin. However, the nice thing about futures is that they are so quick and the fills so clean that you can get stopped out, then a few seconds later you are right back in. You can't be afraid to take small losses, period. Reentry is only a commission away.

• Electronic contracts were set up specifically for traders: They are super liquid and fills are instantaneous.

• If you think the market is going to breakout, you can buy a stock like INTC and watch it sit there while the market roars on without you. You were right on the market—but your stock pick didn't move with the market. With CBOT mini-sized Dow futures you are trading the market. It is what it is. There are no games.

• You can short on a downtick—this makes a huge difference in trying to get filled during a breakdown. If you short KLAC "at the market" on a breakdown, you may not get filled for 20 cents until it has an uptick. If you short the futures "at the market" on a breakdown, you get a quick fill at the current market price. With stocks, you had "bullets" for a while where you could set these up with your broker and short a stock on a downtick. Unfortunatley, these were recently removed.

• I used to be a big trader of OEX options for day trades. After trading futures, I stopped trading OEX options. The spreads and premium of options now looks ridiculous. Where else can you be dead right on an intraday move and still lose money? The OEX options market! Although I do use options for swing trading, I wouldn't day trade them with a 10 foot pole. Not when the CBOT mini-sized Dow futures are so clean and efficient.

• You can do most of your trades "at the market" and get good fills, unlike stocks and especially unlike options.

• For stocks, you need $25,000 to day trade. For futures you can open an account with $5,000 (or less) and day trade. There is no "day trading" rules or classifications.

• To buy one of the futures contracts discussed in these trading lessons, you need about $2,000 in your account. This varies by broker, and can be lower, but this is an average. This "deposit" money required by a broker before you can start trading is called margin, and you can think of it like putting down a 3% down payment on a house. So if you have a $10,000 account, you can buy 5 contracts, and sometimes more by utilizing lower intraday margin rates. However, for money management purposes, I heartily recommend giving some thought to how many contracts you trade in your account. This is a critical part of your trading plan. Just because you can trade 5 contracts in a $10,000 account doesn't mean you should! I typically trade 1 contract for every $10,000 to $15,000 that is in my account. This way your account swings will not be as severe, and you will be able to trade with a level head. One trader friend of mine trades 1 contract for every $50,000 in his account. He makes money and is never stressed out. For managed accounts, I usually trade 1 contract for each $25,000 in the account. Conversely, I've seen programs that say to take a $5,000 account and trade 5 contracts, and by doing this you can make six figures a year. This is insane and you would be better off donating that $5,000 to charity, because you will lose it all trading it that way. There are few guarantees in the futures industry, but losing all of your money trading with this much "maxed out" margin is the one sure bet available today.

• There are now futures on stocks. Using Single Stock Futures traded in the U.S. at OneChicago as swing trades in combination with index futures is a great way to trade and hedge your bets. Although some of the symbols have low actual volume, the "real volume" is based on that of the underlying stock. If you want to buy 100 contracts (1 contract = 100 shares of stock), and you put in a limit order in between the bid and the offer, you will get a nearly instantaneous fill.

• With futures, at the end of the year you don't have to list each individual futures trade like you do stocks for your U.S. tax return. You get a 1099 form from your broker with your total profit or loss for the year. All you put on your tax return is that number on the 1099. That is much easier and much less time consuming than listing out every trade, like you have to do with stocks. And the good news is taxes! For stocks, you have to hold them over a year to get classified at the cheaper "long term gain" rate. For futures, you get a 1099 that says, for example, $20,000 in gains for the year. Of this, 60% of the money is treated as long term gains (lower tax rate) and 40% at the short term rate. This is the "60/40" rule. This rule holds true even if you go flat at the end of every trading day.

• You can trade futures in your IRA. This means you can short stocks in your IRA (Single Stock Futures) or the indexes, which you are not allowed to do in a regular IRA. To set up your IRA for trading futures, you need to first go through a Trust Company set up specifically to do this. What you then do is open an account with the Trust Company, and then they will wire the funds to your futures broker. This way it stays classified as an IRA and you don't have to pay taxes on any gains. Not every futures broker is experienced with this. If you are interested in doing this, be sure to work with a broker that has done this before. It is one way to bring diversification to a portion of your retirement funds.

• Each stock index futures vehicle has four contracts that are traded each year: March (H), June (M), September (U) and December (Z). You will want to trade the closest month, as that is where the volume is concentrated. For example, if today is February 15, 2005, then the closest month is the March 2005 contract. To get a quote for the March 2005 contract on the CBOT mini-sized Dow, you would enter in the symbol, month and year. In this case, that would be YM (symbol), H (Month = March), 05 (Year = 2005). The full symbol would be YMH05. This is for TradeStation. For Esignal it would be YM H5. Each quote service is a little different. When one contract expires, you just start trading the next contract out. TIP: The stock index futures expire the same day as options expiration, on the third Friday of the month they are being traded in. However, you will want to start trading the next month out the week before expiration, as all of the volume will switch to the next month on Thursday of the preceding week. Bonds actually switch three weeks early. Each contract is a little different. If you aren't sure, just ask your broker, write it down and put it next to your PC (or email CBOT or CME to find out what you need to know, if it's not already listed on their websites). This way you will never mess this up. Also, because these are futures contracts expiring at different dates in the future, there is always a price difference between two contracts based on the market's expectation of where each contract will settle. While the March 2005 contract might say 10686 for the CBOT mini-sized Dow, the June contract might say something like 10694. Also note there is usually a 10 to 20 point different between the CBOT mini-sized Dow futures price and the Dow Jones Industrial AverageSM cash price. There is a very complicated explanation for this involving "fair value" and "future price projects" and yada, yada, yada. Bigger picture this it is just something to be aware of. Keep this in mind as you are switching contracts and calculating pivots.

That's the basics. The key is to just get comfortable with your futures broker layout. Do some "paper trades" on their simulator to get a feel of the system, and when you start out, just trade one contract to get a feel of how it works. You will make mistakes, and a mistake on 1 lot is a lot cheaper than a mistake on 10 lots or more. If you have never used a futures broker before, be sure to talk to other traders to check out rates, levels of service, and so forth.

If you want some more "Futures 101" reading, the CBOT has a publication called "Trading In Futures - An Introduction" that you can read online or order for free, plus there's an online interactive tutorial available in the education area of www.cbot.com.

Let's now take a look at why the CBOT mini-sized Dow is my favorite futures contract to trade.

Profitable Futures Trading.

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Futures Trading 1 - Introduction

I'm Familiar with Stocks, but How do Futures Work? - by John Carter

This is the question I get asked most often by other traders who are not familiar with the futures markets. I started off as a stocks and options trader, so I know what you are thinking. They're scary, right? Yet in my experience, once you understand and then trade futures, you never go back to stocks.

Think of this as a "quick blurb" that will help you better understand the futures markets. This is by no means comprehensive—there are entire books written on the subject. However, if you have traded only stocks, the futures markets are probably a mystery and maybe even a little menacing. Yet if you have already learned the importance of strict money management, you will really appreciate what futures trading has to offer. Typically, once people try trading futures, they simply stop trading stocks. The ease of entry on both the long and the short sides and the ability to focus on a few markets instead of hundreds of stocks makes them a refreshing change to the world of stocks. Here is how they work:
First off, there are many types of futures contracts. You can trade anything from Copper to Coffee, from Stock Indexes to Silver, or from Pork Bellies to Palladium. Don't worry about most of these for now. At some point, after you become comfortable with trading a handful of these, you may want to look at more of them. But I know many traders who have traded one market all of their trading lives and are doing quite well, thank you. These are the main futures markets that I follow:

• CBOT mini-sized Dow (YM)
• E-mini S&P (ES)
• E-mini Nasdaq (NQ)
• Full-sized 100 oz. Gold (ZG)
• Full-sized 5,000 oz. Silver (ZI)
• 30-year U.S. Treasury Bond (ZB)

Note that some of these are "mini" and some of these are "full-sized." There are full-sized contracts on the Dow (DJ), S&P 500 (SP) and Nasdaq (ND), but these are pit traded and I prefer to trade the smaller "mini" electronic contracts. Why? Because of the transparency and immediacy of electronic trading. The new full-sized 100 oz. Gold and 5,000 oz Silver electronic contracts are a refreshing change from the old pit traded Gold (GC) and Silver (SI) contracts. Again, I much prefer to trade the electronic version of these contracts over the pit traded versions. There are also CBOT mini-sized Gold (YG) and mini-sized Silver (YI) electronic contracts which are good to trade. The fact that CBOT has both full and mini-sized Gold and Silver futures simply means you have a choice to trade the contract more appropriate for your account size. The important thing to remember for the off floor (as in the Exchange's trading floor) trader is to focus on electronic contracts instead of pit traded contracts. Electronic fills are instantaneous and the markets fully transparent, leveling the playing field for all participants.

In addition, the trend in volume appears to be flowing out of the pit contracts and into the electronic contracts. The electronics are where the action is, and that is where you want to be trading. To get charts on the above contracts, you will have to tell your quote vendor that you want to add quotes from the CME (for the ES and NQ) and the CBOT (for the Dow, Bonds, Gold and Silver). CBOT Advantage, CBOT's data product, offers a two-week free trial for quotes and charting that you can use to check out both markets without plunking down any money. By the way, the word "E-mini" is branded by the CME (Chicago Mercantile Exchange), which is why you see "mini-sized Dow" instead of "E-mini Dow" because it trades on the CBOT (Chicago Board of Trade), which is a different exchange.
Although I follow YM, ES and NQ, I prefer trading YM. I will talk about why I prefer trading it in the next section. Here is a video that shows you how to find additional information regarding the futures contracts you want to trade. This will help you leap frog ahead of any other beginning traders.

Profitable Futures Trading.

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