The Uncertainty of Trading E-Mini S&P Futures
Do you like to trade in and out of stocks quickly?
Are you always looking to take profits and move on?
I use the S&P futures in my analysis, but this logic of uncertainly applies to any trading strategy.
A more diversified way to trade stocks is to buy and sell the S&P 500 E-mini Futures. I like it because I don't need to focus on what's happening with one particular company. Just a general knowledge of where the market is heading, as a whole, is useful.
In addition, trading futures is treated better tax-wise because the IRS allows 60% of the gains to be taxed as long-term gain even if you hold it for only one minute! It also requires fewer resources to hold a contract on futures than it does to own the equivalent value in stocks.
There is an important thing to understand: It’s highly leveraged. One E-mini S&P contract is equivalent to 500 shares of the S&P index (Symbol: SPY). So you really need to know how to control your risk. You can’t let emotion guide you. And you can’t be greedy, as that will make you mess up your trades.
This article is focused on giving you an understanding of what I learned by actual trading based on my prior college education in statistics and logic.
How I Began Trading S&P Futures
When I started trading the S&P Futures, I always protected myself with stop loss orders on every trade. I decided to limit my losses to $200 and let my winners run a little further, but taking the profit quickly before it turns around again.
The process is called scalping, taking small profits from tiny moves. This can be done in either direction, up or down. Just take the profit from the move, as long as you chose the right direction.
I thought this would be a reasonably sure thing. My reasoning was that every trade has a 50/50 chance of going in my favor. That's how it is with buying stocks. The odds are pretty much balanced.
So if I force half my trades to be limited to losing $200 while at the same time allowing half my trades to make more than $200, I thought I'd be on the positive side most of the time.
That didn't work. I got stopped out half the time.
And the other half the time, those trades that went up high, always came back down to the point where I just had a $200 gain.
Not wanting to give it all back, I had another rule, when a good trade seems to start coming back down, get out while I still have a gain.
Well, with all that, you can see that on the average I was gaining $200 half the time and losing $200 half the time.
Due to my strict discipline and risk management, I never lost money by trading Futures. But I wasn’t making money either.
Some Futures traders who start out, do so many things wrong that they lose all their money. They either trade too big, they trade on greed, they let emotion get in the way, or they don't use protective stops. It's important to get a handle on these things.
Analysis of the Trades
As for me, I was keeping a detailed log of all my trades. After a while, I had enough data to have something sufficient to analyze.
Looking over all my losing trades, I discovered that I was always right. Every single trade that I was stopped out on with a $200 loss, had later turned around and would have become a $200 gain – Most within the same day, and a few by the next day. But none took any longer than 24 hours to turn around.
Hold your horses! Before you run and try this for yourself, I need to tell you how it goes through the process of a losing trade to a winning trade, and the risks involved. There are no sure things in trading. If there were, everyone would be billionaires.
The process involved vicious swings. Without a protective stop to limit risk, I found the losing trades would go very much in the wrong direction before turning around. It was not uncommon to be sitting on a paper loss of one or two thousand dollars, before turning around and ending up with a $200 gain.
As I tested this theory, I always placed a closing order to take just $200 because I didn't want to be greedy. Greed is something that I learned to avoid for successful trading.
Roller Coaster Trading
So what have I learned? I was always right. All I had to do was to wait and be patient. But in between, it’s a roller coaster–one that we have to endure for this to work, I imagined. If one doesn't have the trading capital to warrant such a risk, it's not feasible.
I still had a risk limitation that I imposed on my trades, but I set it way down in order to give each trade enough wiggle-room to go through that roller coaster ride.
Based on my analysis, it sure looked like I can't lose as long as I was willing to experience big losses without panicking and pulling the plug while a trade went through its gyrations.
Is this practical? Will it work each time? Can it really be true that I am always right as long as I wait for it? There are reasons why it seems to work, but it is extremely uncertain that it will be consistent. Read on to learn why.
The Reason Why It Seems to Work
In order to figure out if I stumbled upon a sensible method of trading, I first have to explain why it seems I was always right.
I was trading in small market moves, taking losses and profits in the same day, usually within less than an hour, from small fluctuations in the market in either direction.
Within such as small timeframe, the market has constant minor gyrations. It never moves consistently in one direction. Even when there is a perceivable trend, it still fluctuates within that trend.
So when trading within a tight range, even when I'm wrong on the direction, it has been working out very successfully that those gyrations would bring the trade to me for a win, as long as I was patient, trading small, and taking small profits rather than going for a home-run.
I can see that this logic may not hold up when trading longer-term for bigger gains. Some very successful traders put on trades that run for months or years at a time. That's a different ball game. They have to be right for the right reasons.
Trading for small gains taken from small minute-by-minute market gyrations allows one to be right for the wrong reasons. But is this feasible?
The Uncertainty of Trading
Is this a good thing? Did I really learn something beneficial, something that I can use for the rest of my life making money?
Sorry to disappoint you, but I'm not telling you to do this. I've studied logic and statistics in my college days, and I do realize that what I think I had learned from my trading experience is only the tip of the iceberg. I know that there's a bigger part to the puzzle that is hidden from view.
How do I know this? Mainly because, as I mentioned earlier, if there were to be a sure thing, everyone would be billionaires.
So what am I missing with my reasoning? One word: uncertainty!
My logic may be right. But statistically it's still only 50/50. If I were to put complete trust in my idea and allow major moves in the wrong direction–thinking that the market always turns around, the day will come that this rule breaks and the market continues to move against me. It not only can happen, but it will happen.
There are many traders who are very successful with trading Futures. And when you read about their stories, every one of them experienced a major loss at one time or another.
The trick with success is limiting those losses and keeping them small, within reason based on the amount of trading capital available.
Jack Schwager shares critical lessons he learned by interviewing some of the best Futures traders. I found this to be a very honest presentation without the hype of unrealistic success some other books claim to provide.
What Did You Learn?
So what have you taken away from this discussion of my experience and my thoughts?
My hope is that I taught you one important thing. That is that once we feel we discovered something that works with trading, or even longer term investing, it can change in a heartbeat. The game can change before we even realize it.
That's the thing to be cautious about. Whatever you do, whatever you believe works at the moment, always keep the notion in the back of your mind that you're missing something in your reasoning that can change anytime.
The ideas I discuss here are for educational purposes only. I am not making any recommendations. You are solely responsible for your own investment and trading decisions.
© 2014 Glenn Stok