Sometimes, smaller is better. And futures contracts are one of those times.
Futures contracts usually lie far outside the periphery of traditional investors. Traditionally the playground of institutional investors and hedge funds, futures are contracts that obligate someone to buy or sell a commodity (say, corn) or financial instrument (say, bonds) at a pre-determined price in the future.
You can see why individual investors might stray away.
However, E-mini index futures — which literally are miniature versions of the contracts — are a bit more accessible. Specifically, E-mini index future contracts are a great way for average investors to invest in something as simple as market direction. The Chicago Mercantile Exchange offers a number of these contracts for indices like the Dow Jones Industrial Average, S&P 500 and Nasdaq.
For instance, think the Nasdaq is about to make a run? Analyze the macroeconomic climate, technical patterns and indicators, investor sentiment, momentum swings or whatever it is that helps you decide whether the Nasdaq is likely to advance. Then trade E-mini NASDAQ Composite Futures to profit off a move north.
And as nice as the simplicity of it all is, there’s actually several other reasons to trade E-Mini Index Futures:
One reason why futures contracts are bigger among institutional investors and hedge funds is the sheer cost involved. Futures contracts have high margin requirements — which is collateral to cover the credit risk. In some cases, futures’ margin requirements can hit into the tens of thousands of dollars.
And just like E-mini futures contracts are miniature versions of futures contracts, E-mini prices are mere fractions of the costs of their larger counterparts.
Highly Correlated Equity Markets
Asset prices are more closely linked today than they have been over much of the past decade. The technical term is “correlation,” meaning that U.S. stocks and the broader indices frequently move in tandem with other markets around the world. Bad news comes out of Europe? The U.S. equity markets tank across the board.
To make money trading individual stocks, you first must develop a point of view on the overall stock market. Is it going up or down? You then have to roll up your sleeves, do lots of research and choose an individual security. The problem with this approach is that the highly correlated markets are working against you. You might have the stock picking prowess of Warren Buffett, but the stock you pick still is likely to rise or fall based on the direction of the overall market.
Why not save yourself all that time, work and headache? Figure out the direction of your favorite index (the S&P 500, for example) and leave it at that. Trade the E-mini S&P 500 contract on the Chicago Mercantile Exchange instead.
Leverage is the greedy little devil that sits on investors’ shoulders. Leverage, be it through futures or through multiplying ETFs, give investors the chance to make much greater gains on an investment than they could through a conventional security — and just like those same futures and ETFs, you face the potential for massive losses.
For instance, the E-mini S&P 500 is priced at $50 per point, so a 10-point gain in the index would net an investor $500 — much more than you would get for the same day’s trading in, say, the SPDR S&P 500 ETF (NYSE:SPY). Of course, a bet in the wrong direction, and you can see how the downside is equally as magnified. The upside is, the relatively low capital needed for trading E-minis at least makes the leveraging a bit easier to swallow.