The Powerful Advantages of Trading the E-Mini S&P 500 Futures over Stocks, ETFs and Forex
Have you ever wondered why many 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. Make no mistake, there are substantial risks involved with futures daytrading and it is not suitable for all investors, but we feel the following 20 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 have a tight bid-ask spread of typically 1 tick or $12.50 per contract. With a current approximate contract value of about $140,000, that comes out to .001% 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-ask spread may be much wider. Also, since Forex firms “create” the market and therefore, the bid-ask spread, they can widen it to whatever they see fit. Even when Forex firms advertise a fixed spread, they typically reserve the right to widen when they see fit. Typically, this spread is anywhere from $15 to $50+ depending on the currency pair and market conditions.
2. Central Regulated Exchange
All ES trades are done through the Chicago Mercantile Exchange and its member firms where all trades are recorded in an official time and sales. 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. Traders with different firms can experience different fills even when trades are executed simultaneously. Even more alarming is that in some 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,” rebate or kickback for your order or they go to dark pools or are shown to flash traders before made available to the public. Again, this can become a conflict of interest since your order may not be getting the best possible execution.
3. Low Commissions
ES commissions are only $1.99 (not including exchange, NFA or data fees) per side and larger traders can even lease a membership to further reduce their fees. This low transaction cost allows daytraders to get in and out of the market without commissions significantly cutting into their profits, but of course the more trading you do the more this will impact your bottom line.
While most Forex firms do not charge a “disclosed” commission, they make their money by creating their own bid/ask 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 asks along with the associated volume in real time and you are 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 may be very valuable and may be used as an indication of future market movements.
Most Forex platforms do not offer Level II type pricing and for the few that do, 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/ask spreads, further limiting your trading abilities.
5. Virtually 24 Hour Trading
The ES futures market is open from Sunday night at 5p CST until Friday afternoon at 3:15p (it halts from 3:15p-3:30p and also closes daily from 4:00-5p for maintenance). This allows you to enter, exit or have orders working to protect your positions almost 23 hours a day, 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 and all orders are matched by a computer on a first come-first served basis no matter how large or small they are. This means that all traders see the same level II market and bid/ask spreads with an equal chance to hit them.
While most Forex firms offer electronic trading, some 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/ask spreads.
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 $140,000 and can be daytraded for as little as $500 which is .36% of its total value (about 300:1 leverage). Even if you hold a position overnight, the current overnight margin is only $6,600 which is still less than 5%.
Not all stocks and ETFs are available to be traded on margin, and the ones that can, require at least 50% margin (2:1 leverage) to do so. US regulated Forex firms are not allowed to offer more than 50:1 leverage on the major currency pairs and 20:1 on the other currencies. This high margin requirement may be very limiting to daytraders who are only looking for small market movements.
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 $3,000 and do not have any Pattern Daytrader Rules associated with them. Of course only risk capital should be used no matter what the amount is that you choose to start with.
The SEC describes a stock 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.
The Emini S&P futures trade about an average of 2 million times a day which allows for great price action, volatility and speedy execution. At a current approximate value of $140,000, that is almost $300 billion changing hands every trading day.
Not all stocks and Forex markets are as liquid which means movements can be shaky and erratic, making daytrading more difficult. Forex firms like to make the claim that the over the counter foreign exchange market trades more than one trillion Dollars in volume per day, but most people don’t realize is that in most cases you just traded against your broker’s dealing desk rather than the true interbank market.
11. Tax Advantages
US Futures traders have favorable tax consequences for short term traders since futures profits 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. Tax laws are subject to change and you should consult your accountant for any tax advice.
When trading a stock index like the Emini S&P futures 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 are susceptible to stock specific risk which can occur without warning and with violent consequences.
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 segregated funds rules laid out by the US government.
Even with regulated US 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.
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 follow the futures indices, and not the opposite. In fact, many stock traders will have an Emini futures chart up next to the stock they are following. 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. Go Short
There are no rules against going short the ES, traders simply sell short the ES contract in hopes of buying it back later at a lower price. There are no special requirements or privileges you need to ask your futures broker for.
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 in the past the government has put temporary bans on stocks that can be shorted.
16. Direct Correlation
On average the ES futures are directly correlated to the underlying S&P 500 index in the short and long term. If you pull up an Emini S&P 500 futures chart and compare it to the S&P 500 index chart they should almost look identical.
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 which could hinder their ability to correlate.
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 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 benchmark 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 Emini futures?
19. Volume Analysis
Volume can be one of the most useful indicators a trader can use, those little lines at the bottom of the chart are not just there to look pretty they should be used as another indication of the validity or lack thereof, of a particular move. In other words combined with other indicators and/or chart patterns volume can be used to confirm a move in the market. Most market technicians would agree that a move made on relatively light volume is not as significant as a move made on heavy volume and should be treated accordingly.
Since the Forex market is over the counter (OTC), there is no centralized exchange, no one place where trades take place therefore, there is no accurate record of volume and most, if not all, Forex charts will not show any indication of volume. So what might appear to be a significant move on a Forex chart, may just be a false move on low volume and could not be filtered out if you were looking at a Forex chart.
20. Clearing Reliability
During the May 6, 2010 “Flash Crash” the Emini S&P futures continued to trade within a reasonable price range reflecting what the cash S&P 500 index was indicating. No trades on the Emini S&P futures were cancelled and all trades cleared.
According to the joint study by the SEC and CFTC, ETFs made up 70% of the securities with trades that were later canceled. Furthermore, there were about 160 ETFs that temporarily lost almost all of their value and 27% of fund companies had securities with trades broken. Had you bought or sold during this event you may had been notified after the market closed that your trade was no longer good and left with potentially dangerous consequences.
As you probably already know trading is hard enough, so why choose a market where the odds are stacked more against you before you even place your first order. The above mentioned 20 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. Before you trade futures, though, please make sure they are appropriate for you and that you only use risk capital.