Why Trade Financial Futures Instead of Stocks or ETF's? In A Word -- Leverage
The Financial Futures Market offers a unique allure to professional day traders, far more so than trading individual stocks, or even stock ETF's such as the SPDR's. To sum up the attraction in one word...leverage.
Leverage is a means by which day traders can increase the potential return of their investments through borrowed capital, such as margin. Trades are considered to be highly leveraged when the asset can be purchased for a small fraction of the asset's total value.
The SPDR® S&P 500 (ticker SPY), commonly known as Spyders or Spiders, represents an exchange-traded fund (ETFs) that is designed to track the price and yield performance of the S&P 500 stock market index (the 500 large-cap common stocks actively traded in the United States).
SPDR shares trade for roughly $125/share and use the same day trading leverage as stocks, 4 to 1. In this way, for every 4 shares traded, day traders must have roughly $30 in their account. Since SPDR's trade in penny increments, for every one penny movement in their direction, day traders are rewarded with 1 cent. Most day traders will normally trade 100 shares, or $3000/trade. For each penny increment they'll make $1.00. This, however, would be considered small leverage. Risk $3000 to earn $1.00 for each price movement. Take a look at another example. Instead of choosing an entire index such as the SPDR, choose an individual stock in the S&P 500 index. It must be a volatile stock, one with enough volume to make it attractive to day traders. Volatile stocks vary considerably in price, anywhere from $25/share to $200/share. Let's go with a $50/share stock. Again, the 4 to 1 ratio, day traders need roughly $16/share or $1600 for $100 shares. Like SPDR's, stocks also trade in penny increments, so for every 1 cent movement again $1.00 is earned. While the leverage nearly double that of SPDR's, it is still $1600 to $1.00. And that is if the stock trades just $50/share. Here's a major drawback for both SPDR's and stocks...commission. Even low discount commission is generally $5.00/side. The price increment would really have to move 11 cents to make the $1.00 profit after paying off the brokerage. There is an alternative leverage to tracking the price performance of the S&P 500 stock market index...trading Emini S&P 500 Futures Contracts (ES).
The ES began trading in 1997 with roughly 7,000 contracts daily. Because it is so attractive to professional day traders, it has now grown to be one of the most popularly traded instruments in the US, averaging in excess of two million trades per day. Here's the best part. For technical day traders, the SPDR chart, the charts of individual component stocks in the S&P 500, and the ES chart are nearly one and the same. Whatever technical analysis tools are used in trading the stocks and ETF's work great trading the ES.
While stocks and ETF's have limited volatility and/or liquidity pre-Market (before the Market opens at 9:30am EST), the ES trades well nearly 24 hours / day, with lots of volatility and volume.
Here's the most important difference. Unlike stocks and ETF's that offer $1.00/100 shares, one ES price increment is $12.50. And day traders don't need $3000, or even $1600. S&P 500 Emini's trade in contracts instead of shares. To trade one ES contract is as little as $400-$500, depending on the brokerage. Now that's highly leverage. Put up $400 and earn back $12.50. Commissions have been reduced as well to as little as $3.95 round trip.
Why should day traders invest in stocks or ETF's when the leverage is all in the financial Futures. It's the same trend, same charts, same technical indicators. Day traders can more quickly realize their daily goals with fewer trades. Fewer trades equals less overall time in the Market. Less time in the Market equals reduced risk.
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