Basics of S&P 500 Futures Trading

If you're brand new to futures trading, this document will clarify the terms used in the Daily Directional Forecast, and help you get started trading the most exciting market in the world -- the S&P 500 futures.

Our subscribers come from the entire range of traders, from seasoned professional fund managers and floor traders to novice traders and those looking to trade the S&P futures for the first time.

But one thing we all have in common is we're looking to know what the market is going to do that day. With Mohan's Market Force - Daily Directional Forecast, you'll receive crystal-clear, accurate calls on the market.

What are we talking about?

The primary objective of our Daily Directional Forecast is to help traders get on the right side of the market during that day's session, to capture 8 to 10 points in the e-mini S&P 500 Index futures. Of course, trading futures involves risk and there is no guarantee of profit.

I have been trading the S&P 500 Index futures for many, many years and that is the sole focus of my Morning Call -- to make directional calls on the S&P 500 futures for that day's session. All the numbers, trade setups and discussions deal only with the S&P 500 Futures contracts traded at the Chicago Mercantile Exchange (CME). I do not talk about the S&P Cash Index, OEX Options or anything else when talking about trading and "the market", although certainly there are other markets you can trade using my Daily Directional Forecast.

What are S&P 500 Index futures?

Equity traders entering the futures markets for the first time should consult the excellent information available from the Chicago Mercantile Exchange (CME). Also, many futures brokers can provide you with the specifics of the contracts and give you all the details you need about risk/reward, leverage, and the capital required to trade the contract.

The CME offers two sizes of the S&P 500 contract: the standard "big" futures contract and the S&P 500 "e-mini" contract. The standard contract is what the institutions and commercials trade, and the majority of these trades are done using the "open outcry" auction system in the pits of the Chicago Mercantile. This contract is known variously as the Big S&P, the Big Car, SPoos,etc. -- and the trading in this big contract sets the tone for the entire stock market. Most of the analysis we do at Mohan's Market Force - Daily Directional Forecast is based on the trading in this contract.

For actual trading, our numbers focus on the e-mini contract. The "e" stands for "electronic," as this contract is exclusively traded on the CME's electronic, GLOBEX platform; and the "mini" represents the fact that this contract is one-fifth the size of the big contract.

At one-fifth the size, the e-mini is more affordable to retail traders, with lower day-trading margin requirements. This contract is traded electronically, resulting in high volume action, with volatility spikes beyond the range set by the big S&P for short periods. But generally the price action tends to follow that of the big S&P contract very closely.

But...what exactly is the e-mini contract?

The E-mini S&P 500 futures are legally binding agreements to buy or sell the cash value of the S&P 500 Index at a specific future date. The contracts are valued at $50 * the futures price. For example, if the e-mini S&P 500 futures price is at 920.00, the value of the contract is $46,000 ($50 * 920.00).

This also means that the value of the contract changes with every point the futures move. If the futures price is 922.00, then the contract is worth $46,100 ($50 * 922.00). If it slips to 918, the contract is worth $45,900 ($50 * 918.00). If you own or short an e-mini futures contract on the S&P 500, you are gaining -- or losing -- $50 per point.

Like all commodities futures, you are required to only put up a fraction of the contract value to actually take a position. This amount is popularly called "margin," but it is unlike the margin requirements in stock trading. It is not even margin, but rather a "performance bond," in which you agree to honor the terms of the contract by either offsetting it before expiration or making a cash settlement. The amount of the performance bond is specified by the CME. Currently it is about $3,500 per contract (See table below).

If the market moves against your position, you may be required to add additional funds to maintain the necessary bond levels. Please consult your broker for his house rules for posting the bonds (margin), and always strive to be aware of your liabilities and obligations.

Ticks

The minimum price movement of a futures contract is called a "tick." The tick value for the e-mini S&P is 0.25 index points, or $12.50 per contract. This means that if the e-mini moves the minimum price increment (one tick), say, from 920.00 to 920.25, a long (buying) position would be credited $12.50; a short (selling) position would be debited $12.50.

Trading this contract offers tremendous leverage, which is also a double-edged sword. Relatively small amount of capital can result in huge percentage gains -- but it can also quickly result in big losses and total wipeouts. Often this catches traders migrating over from equities by surprise. Futures trading requires vigilance, discipline, and fortitude.

With the normal day-trading margin of $2,000, one of our typical 8-10 handle (see the upcoming section, "What is a point?" for explanation of the term handle) trades will net you a $400 to $500 gain, before commissions and fees. That is a 20% to 25% return. To get yourself really excited, you can annualize the return. But we're not going to do that! Instead, we will point out that it's just as easy to lose all your capital and end up owing money to your broker.

The need for discipline cannot be emphasized enough when trading the e-mini.

Contract Months

E-mini S&P 500 contracts are cash-settled, just like the standard S&P 500. There is no delivery of the individual stocks. Just like the big S&P, e-mini contracts also expire quarterly. E-mini S&P 500 daily settlements and quarterly expirations will use exactly the same price as the S&P 500, thus benefiting from the liquidity of the big S&P 500 futures.

S&P 500 Index futures contracts expire each quarter, always on the third Friday of March, June, September and December. Contracts with several expirations are traded simultaneously. Mohan's Market Force - Daily Directional Forecast focuses only on the leading month contract, which is by far the most actively traded.

Ticker symbols are created by combining the base symbol ES, the contract month and contract year. Month codes are:

                                                H=March
                                                M=June
                                                U=September
                                                Z=December

Therefore the ticker for the June 03 contract is ESM03

The symbol for the big car is SP and is built up the same way: SPM03

So how many shares do you buy?

This is a common question from equity traders when they start looking into futures. The answer is: You don't. Just like options contracts, you buy single or multiple contracts. Most beginning traders and many experienced traders only trade a single contract -- "the one lot." If you are a beginning futures trader, it is important to establish a consistently-profitable method, over a period of time, before increasing lot size. In other words, start small!

Trading ‘round the clock...

Except for Friday evening through Sunday evening, the e-mini trades virtually around the clock. Mohan's Market Force - Daily Directional Forecast' day-trading methodology is based on volume and price action of the pit trading session, also known as Regular Trading Hours (RTH), beginning at 9:30am Eastern Time until 4:15pm Eastern Time, for 405 minutes of nonstop fast action.

The Daily Directional Forecast concerns itself only with the RTH trading session. Being hardworking "blue collar" types, we punch the clock at 4:15pm, pocket our paycheck and head home to relax with family and friends. There is more to life than the markets.

What is a point?

Equity traders are sometimes confused by varied interpretation of "points," for understandable reasons. According to CME contract specifications, one point is 1/100 or 0.01 of an index point. Using this definition, the e-mini moves in 25-point ticks. To avoid the confusion of index points versus contract points, the term handle is used to describe one index point and the index price levels.

Therefore if the S&P 500 Index futures move from 950 to 955, it is said to have moved from 950 handle to 955 handle for a move of 5 handles (index points) or 500 contract points.

The numbers

Daily Directional Forecast provides some key numbers for plotting the session's road map. For computing our various proprietary indicators, only the numbers of the big contract are used. All the previous day's session numbers, moving averages, and Market Profile Value Area numbers are based on the price action of the big S&P 500 Index Futures contract.

The Buy and Sell pivots are rounded to the e-mini tick size, since most traders use the e-mini as the trading vehicle.

Index numbers discussed as part of the High Five are the Dow Industrial Average and the Nasdaq Composite Index. These are the cash indices universally available and quoted as broad market averages.

What's a pit bull doing in there?

The Pit Bull Moving Average is what we named this important number in honor of Marty Schwartz, the legendary S&P trader. In his book, Pit Bull, Schwartz describes how he computes and uses this average. His calculation is based on a10-Day Exponential Moving Average.

During his trading career, I have found that the Simple Moving Average does an admirable job as well, and this level is watched closely by floor traders and insiders. The name "Pit Bull" is given to honor Mr. Schwartz; the method of computation is 10-Day Simple Moving Average. To get this figure, add the last 10 days' settlement prices of the big S&P futures, and divide by 10.

LSS is not an abbreviation for that "L word" with "O" taken out

LSS is a day-trading method, originally developed by a 1950s grain trader named George Douglas Taylor, who identified a three-day cycle known during his time as the "Book Method."

This was further refined by George Angell and published as the "LSS" method, which stands for "Long, Sell, Short sell. My long-term observation and study of this method has resulted in my breaking the code on this cycle, and it's one of the most important parts of my analysis of the market.

Abbreviations you may wonder about

B/O means "breakout," and refers to the price breaking out above the high point of the first hour of trading during regular market hours on the e-mini S&P500.

B/D means "breakdown" and refers to the price breaking down below the low point of the first hour of trading during regular market hours on the e-mini S&P500.

Value Area

Value Area is a price range where the highest volume trading occurred. It is part of a system called "Market Profile," which was originally developed by a trader named Steidelmeyer, and later licensed by the CBOT. We offer this important trading zone each day in our Daily Directional Forecast, plus daily commentary about how to interpret the action in this zone during the trading day.

Master yourself...master your methodology

Trading the S&P 500 Index futures is serious work. You are pitting your wits against the most seasoned and well-funded professional traders in the world.

The Daily Directional Forecast will teach you how to think like a floor trader and market insider. We'll teach you to never be a bull or a bear. Your market opinion simply doesn't matter when you're trading the e-mini. All you want to do is grab your 8 to 10 handles from the bulls or bears, by getting on the right side of the market at just the right time. Our crystal-clear set-ups and instructions will put you in this position time and again.

The rest is up to you! Mastering a methodology takes time, practice, repetition and persistence. Our methods can add significantly to your performance and to your existing methodology. The Morning Call will educate you on reading the markets skillfully, and won't muddle your mind with a plethora of indicators of dubious value. You'll think just like a professional trader.

In the longer term, macroeconomic and fundamental factors definitely influence price levels. But in the short run, markets are moved by sentiment, and are even -- somewhat surprisingly to novices -- often rigged to a pre-planned agenda.

Before jumping in, you'll need to invest in a good trading environment, and you'll need a top-notch set of market tools, including real-time charts and quote services such as those available from eSignal, LocalKnowledge, TradeStation, Quote.com, etc. You'll also need a fast execution platform and above all, a good broker with not only low round-turn commissions, but quick live-broker assistance for problem resolution.

Many online futures brokers offer simulated trading, which is an ideal way to master the Mohan's Market Force - Daily Directional Forecast methodology without any risk.

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