Editor’s Note:  Since our first issue, we’ve cautioned you against putting your faith in the financial media.

To give you an alternative, we bring you battle-tested professionals who will give it to you straight and empower you to make your own investing decisions.

The financial crisis has at once underscored the failures of the financial media, and has reminded us of how important our responsibility to you is.

So in an effort to make The Tycoon Report even more valuable, we’ve been interviewing fellow professionals who share our passion for educating individual investors.

Today it is my distinct pleasure to introduce you to our newest Tycoon Report writer, Barbara Cohen.

Barbara is a professional trader and educator who specializes in trading futures, a market about which many of you have told us you’d like to learn.

Aside from her professional background and wealth of knowledge, Barbara has a talent for writing and a knack for making the complex easy to understand.

I hope you’ll join me with your comments in welcoming her to the team as our regular Monday contributor!  -- Ben Schott
 

 

 

I’ve never been a fan of investing newsletters.  Most of them, as I am sure you’ve figured out by now, aren’t worth the time they take to read. 

I’m sure you’ve also come to the same conclusion I have about most of them: That the “gurus” writing for them are more likely high-priced copywriters than real traders.

I am, however, a big fan of The Tycoon Report.  That’s because for years I've seen a bit of myself in their articles: People whose profession is trading, but who share a passion for teaching others.

Needless to say, when they called and asked if I would be interested in contributing on a weekly basis to educate you in my particular area of expertise, it was a very easy decision.

My name is Barbara Cohen and, long story short, I am a Futures Trader – more specifically a Futures day-trader.

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 many professional traders, especially daytraders, don’t trade the stock market any longer.  After that, I was hooked.   Now I only trade the Futures Market.  I’ve even delivered seminars on electronic trading inside the Chicago Mercantile Exchange (CME) where they trade Futures.

For those of you unfamiliar with trading Futures, and given that we’re just getting started together, 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?”

Well, here’s the Wikipedia response: “A Futures Market is a financial exchange where people can trade Futures Contracts.”  OK, great.  But 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 major difference between the Futures Market and, say, the Stock Market is that the Futures Market deals in contracts, not shares.  You are not buying a “share (or piece) of a company”.  A Futures Contract is an agreement between a buyer and seller to trade a quantity of a specific commodity or financial instrument, for example, gallons of gas or barrels of wheat.

It is easy to understand how commodities Futures Contracts work.  An airline, for example, contracts for 100,000 gallons of fuel for their planes at a certain price today, but does not take delivery until sometime next year. 

That was how Southwest Airlines did so well when the price of fuel was $140/barrel and other airlines were in trouble.  They had bought Futures Contracts with several oil companies years earlier when the price of oil was cheap, but waited for delivery until 2007-2008.  Now that the price of oil is cheap again in 2009, they’ll be buying Futures Contracts for delivery in 2010-2011.

That’s all well and good, you say, but that’s not trading. 

In every Futures Contract transaction, there is a degree of risk.  Futures Contracts are all about leveraging risk against the value of the underlying asset you want to buy.

Southwest acquired risk in that the price of oil could fall below the price they paid (so they would have ended up paying more than they would have had to).  At the same time, they reduced their risk because they thought (rightly so) that the price of oil would go higher than their contract price. In their case, the leverage paid off.

For the oil companies, they reduced the risk, believing that the price of oil would fall below the contract price they negotiated with Southwest.  But they acquired risk because the price of oil could rise higher than the contract (thus losing additional revenue they could have earned).  In this case, the leverage was not as good as it could have been.

Here’s where you say, “I’m not Southwest Airlines.  I’m an individual investor.  I don’t want to buy 100,000 gallons of oil.  How can 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 barrels 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.

To start, the CME created “e-mini Futures Contracts” designed for individual investors.  The “e” in e-mini simply means that they are traded electronically.  You’ll have a trading program right on your desktop where your trades go directly to the CME.  The “mini” means that the contract is a smaller version of the exact same contract that the larger corporations trade.

The most popular CME e-mini Futures Contract is the S&P 500.  This e-mini is based upon the S&P 500 index that represents the top 500 stocks in the NYSE.  The S&P 500 index is price-weighted, meaning some of the stocks have more “weight” or "pull" than others.  Being larger companies, they can move the value of the index higher or lower more than others. 

And you thought that Futures Contracts were just based on commodities like corn, wheat, rice, crude oil.

Imagine for a moment that you could trade all the top 500 stocks simultaneously.  Now that would leverage risk.  Should one or two stocks not do well that afternoon, you would still have 498 other stocks to trade.  You wouldn’t have to pick any specific stock, nor would you have to spend hours and hours doing research on stocks either.  Why?  Because you would be trading all of them.  Mind you, it would cost a small fortune to be able to trade 500 stocks at one time.  Well, buying and selling S&P 500 e-mini Futures Contracts is just like trading all 500 stocks at the same time, for a fraction of the cost.

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 daytraders gave up trading anywhere but the CME ...

1)  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.

2)  The e-mini is a totally electronic environment.  There are no Market Makers on the CME who might refuse to fill your trade like there are on the NYSE or NASDAQ.  The CME book is FIFO, first in first out.  That makes trading on the CME a level playing field for all traders, whether you are trading 1 contract or 100.

3)  Commission for e-mini Futures is based upon “Round Trip” instead of in-and-out.

4)  The difference between the Bid price (the highest price that a buyer is willing to pay for a contract) and the Ask price (the lowest price that a seller is willing to sell a contract for) is just one “Tick” on the CME.

(The minimum price movement between the Bid and Ask is known as a Tick.  The S&P 500 trades in 25 cent increments. 1 Tick = 25 cents.  4 ticks = 1 point.  If you gain 1 tick in your trade, the reward is $12.50, with 4 ticks = $50.

Compare a 1 tick -- Bid / Ask spread that has no Market Maker with trading securities where the difference between the Bid and Ask can be significant, especially if quoted by a Market Maker who is making his living on the spread difference.)  

5)  Trading an e-mini Futures Contract means that you only have to watch 1 chart, the same chart, every day, day in and day out.  Might you become a really proficient trader if you only had to watch 1 chart?  

Stock traders generally watch a basket of stocks at the same time.  That means they need to watch multiple charts, flipping the charts back and forth for fear of missing some action.

6)  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.

7)  Option traders must be able to correctly handle 4 conditions in order to be consistently profitable:  underlying price, strike price, volatility, and time decay.  Option traders can be right and still lose on their trade because time was not on their side and the option expired worthless before they could profit.  Futures traders are only concerned about 2 conditions:  an advancing market or a declining market.  Time decay is not an issue for Futures traders.

8)  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 daytrader” is anyone who executes 4 or more day trades within a 5 day period.  To daytrade, you must have in your brokerage account at least $25,000 (or your account will be frozen for 90 days if you are caught daytrading).

Daytrading Futures has no such restrictions.  A brokerage account requires far less capital.  Most Futures brokers allow you to open an account with just $2,500.  This opens the trading Market to even small investors.

9)  You can trade the e-mini futures long (hoping the contracts will go up) and you can trade the futures short (hoping the contracts will go down).  Lately, there have been bans put 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 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.

10)   If you want to trade with an IRA or 401k account, once you exit a trade, you won’t have to wait for the trade to settle before you can use that same money for the next trade.  One second after you exit your current trade, that same money is available to you for another trade.  With stock trading, once you exit a trade, you may wait as long as 3 days for your money to settle before you can use that money to trade with again. 

11)  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 is much easier.  Since your broker gives you the net entry, you will make just 1 entry on your tax return.  If you trade stocks, you are required to identify every trade you made.  If you are a day trader and trade multiple stocks, it can take hours to enter all those transactions.  With Futures trading, you are done in a jiffy.

12)  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.

13)  Unlike stocks that may trade on different exchanges and have different Bid/Ask prices, there is only 1 exchange/1 book for e-mini Futures and that is on the CME.  That means for e-mini Futures contracts, there is only one price – the posted price.  With large cap stocks, they can trade on multiple exchanges, with each exchange offering a slightly different price.

14)  Your fills are guaranteed.  If you are in a trade, for example, and the e-mini price goes through your offer, you get filled.  No questions asked.  This is a major problem for smaller Forex traders.  You may be in a trade waiting to exit.  You have an offer to sell.  The Forex contract goes right by your price and does not fill you.  Then you read in fine print on your Forex Brokers contract that they do not guarantee fills.

The CME Clearing House for trades acts as the guarantor to each of its clearing members, thus ensuring the integrity of all trades.

15)  When contracts expire on the 3rd Friday of the contract month, they do not expire worthless.  Your money rolls over to the new contract, unlike 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.

Unfortunately, you only have $5,000 to invest.  You’ve traded stocks before and know that with just $5,000, you would have to limit your investment to just one or two stocks.  That means a great deal of nightly research to determine which stock to choose. 

You could buy a mutual fund to take advantage of more than one or two stock moves, but with upfront load fees your investment wouldn’t go far.  Instead you decide to trade S&P 500 e-mini Futures Contracts.  With $5,000 you could trade 5 contracts ($2,000 – you never want to put all the money in your portfolio on 1 trade).  If you make 4 ticks daily, you’ll be making $170-180/day after commissions.  That is $3,500 per month, or $42,000 a year.  After taking into consideration some losses, say you net $35,000.  On a $2,000 investment!  That’s a gain of 1700% annually.  If you put the $5,000 in the bank and earned 3%, you’d make $150/year.  In one day you could have exceeded the amount the bank would pay you all year long.

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.).

I know that's a lot of information crammed into our first article.  Over the coming weeks, we’ll be looking at exactly how to trade the e-mini’s, and I'll be sharing tips and suggestions to make your trading more profitable.  We’ll take a detailed look at indicators, charts, trading platforms, brokers, margins, commissions, etc.

Until then, I’m thrilled to be able to share with you, and I hope you’ll take advantage of the “Comments” tool to let me know what you think, or to ask any Futures-related questions you may have.