Why Day Trade Futures and not Stocks?

I began my trading career day trading stocks, mostly the blue chip variety.  And there is nothing wrong with day trading stocks, though generally speaking individual stocks do not have the volatility that many day traders crave.  To be sure, stock trading is a longer term proposition and are less prone to to dramatic movement.  For my money, I generally buy stocks to either swing trade, or hold onto for longer term growth.  On the other hand, you can often find individual stocks that oscillate widely on a daily basis and are perfect for day trading, but these instances are rare.  I can recall years ago that Jupiter Systems was a great day trading stock, as I haven’t traded it in years, I do not know the current status of this issue.

On the other hand, the financial requirement for trading index futures contracts lends itself favorably to the day trader.  The key element is margin, in this case.  When trading stocks, Regulation T becomes a prime issue, and Regulation T requires you to put up 50% of the contract value in order to trade the stock.  If you are trading GOOGLE in round lots, say a hundred shares, (google is trading in the low 500‘s) you will be forced to pony up a significant amount of cash in order to trade this stock.

Futures contracts are another matter all together.  Most futures contracts, specifically the emini variety, were specifically designed for day traders.  You can usually find brokerages that offer margin requirements in the range of $500 per contract.   Each point on, lets use the ES emini contract, is worth $50 dollars, and lets assume the ES index is trading in the 1000 dollar range.  Simple math tells us that you are controlling nearly $50,000 dollars with a paltry 500 margin requirement.  In trading, leverage is kind, when used properly.

Once simple consideration should always be forefront in your mind, though.  Leverage will maximize you returns and maximize you losses.  A skillful trader will manage his money effectively, never overextending himself/herself in a given trade.  In my trading, I never like to risk more than 10% of my futures account value on a given trade.  Some traders even lower this amount to no more than 5% on given trade.  This is, of course, a personal preference but the point is a simple one; because of the high degree of leverage in futures contracts, money management is of utmost importance.

For example:  Lets say you have established a $5000 futures trading account.  Generally speaking your futures broker will let you trade up to 5 contracts on this account.  It should be noted that most futures brokerages will not let you trade up to your account limit, and most set trading restriction at about 50% of your account value.  Anyway, there is no way that you should even consider trading your maximum level (5 contracts) on a given trade.  On a $5000 account I would be hesitant to trade more than I contract, maybe 2 if I felt very comfortable with the trade.  Overextending your trading account is a great way to end up broke.  Be judicious in the number of contracts you trade, and always use stops to make sure you don’t get caught in a run away trade in the wrong direction.

Leverage in futures contracts can be a very useful tool to increase your account balance, and your potential to make money is far greater in a futures account than day trading a stock account.  But managing a futures account takes a high degree of skill and self discipline.  There is a constant compulsion to overtrade your account, or trade an excessive number of contracts relative to your account size that has to managed with skill.  Further, it is your responsibility to exercise proper money management when trading futures contracts.

In summary, we have taken a close look at day trading stocks and futures contracts.  Stocks can be suitable investment vehicles to day trade, but because of the leverage requirements in futures contracts they are generally a better choice, but only if you are able to responsibly implement money management techniques that don’t expose you to excessive risk.   Money management is one of the most challenging aspects of trading, and one of the most difficult to master.  I suggested never risking more than 10% of your account on a given trade.

Stocks or Etfs

All traders, when they first come to the market are facing a simple question what to trade and what trading vehicle to choose for investments. While there could be different ambitions and some investors are coming to the market for gambling with a purpose of becoming rich in short period of time I would like to focus on simple investors who have came to the market with confusion and would prefer some not extremely big but stable increase in investments.

Majority of people are coming to the stock market without knowing anything how the market works. All they usually know is that you may invest into stock. They start to look for good stocks and very soon they become frustrated – they start to understand that in order to select a few good stocks they are required to go through hundred of stocks, compare their performance, their reports, study fundamentals, etc.

When I ask some of my friends-traders about ETFs (Exchange Traded Funds) I hear the standard answer that they became familiar with stocks and they prefer to trade stocks. My second question usually is about how he/she does analysis to see what to trade and where to trade (long or short). Now comes interesting part. I would spread their stock analysis in several steps.

Step 1: Spend 1-2 month going through hundreds of stocks from different industries. As a rule, this stage of analysis includes going through earnings and other reports, comparing stock’s performance, analyzing the market sector the stocks belongs to, etc. All this ends with selection of 2-10 stocks that a trader became familiar with and considers that they are good for investments.

Step2: Subscribe to the reports, charts, quotes that cover selected stocks and could be used for further analysis on regular basis.

Step 3: Start to trade by analyzing the selected stocks on the regular basis (doing fundamental and technical analysis). In addition a stock trader continues to analyze selected industry and the whole market – you need to know where the industry and market are going do not to lose the stocks.

Doesn’t it look complicated? Especially when it comes to the fundamental analysis of all the reports… People are learning in the universities how to correctly analyze and evaluate a public company. Do you think an “average Joe” has time and is able to learn all the aspects of the fundamentals and apply it on practice? I am sorry for being sarcastic, yet, I am a little bit skeptical about retail traders (including me) and their abilities to perform liable fundamental analysis of stock. Maybe you can skip fundamentals if you are day trader and trade stocks in short-term, however if you are investing your pension for longer-term you have to do fundamentals – otherwise it is not an investment but a gambling.

So, what is the solution? For me, I trade Exchange Traded Funds. There are plenty of very active ETFs: QQQQ, SPY, DIA, XLF, IWM, etc. The biggest advantage of ETF is that I do not have to do fundamental analysis – no complicated and time consuming job – all fundamentals are done by professionals who manage indexes that are tracked by ETFs. All I do is the technical analysis of indexes I trade. Index analysis is a stock, industry and market analysis at the same time. For instance when I analyze S&P 500 index, the result of the analysis could be applied to trade SPY stock (S&P 500 index tracking stock). At the same time S&P 500 is considered as a barometer of the US stock market and S&P 500 index analysis reflects sentiment on US stock market. So, tell my why should I not to trade SPY, QQQQ and other ETFs and why should I go into complicated stock analysis.