Warrior Trading Blog

E-mini Futures – Everything You Need to Know

e-mini futures

Futures have become a popular financial product for active traders for many reasons, but what are they and how do they work? In this guide we will cover the details behind e-mini futures and how you can get started trading them.

What Are Futures?

Put simplest, futures are an agreement to buy or sell a specific amount of goods at a fixed price at a future date. For example, if you’re a tomato farmer, you may establish an agreement with a local food store to sell them 1,000 tomatoes in three months for $250.

If $250 is an agreeable price to both parties, they’re both guaranteed to lock in that price, and protected from future price volatility. If the price of tomatoes declines, the farmer still gets $250 out of his tomato harvest, and if the price skyrockets, the store still gets their tomatoes for an agreed upon price.

Futures can be tracked back as far as Mesopotamia and Ancient Greece, but futures trading as we know it really started with Japan in the 1700s, where the world’s first futures exchange, the Dojima Rice Exchange, was created.

The purpose of futures is to hedge against future uncertainty. By locking in today’s price, both the supplier and vendor can strike a deal in advance that makes sense to them. 

Futures have an added interesting element in that there are buyers and sellers with completely different objectives. While you and I are trying to trade futures to make a profit, suppliers and vendors are using them as a hedge. So, a large seller doesn’t necessarily indicate bearishness. This concept is still present in the stock market, just not to the same degree as in the futures markets.

What Are E-mini Futures?

In the 1990s, the S&P 500’s price got too large for a standard futures contract (usually $250 times the price), so E-minis were created, which are one-fifth the size of a standard S&P futures contract (E-minis are $50 times the price of the S&P 500, as opposed to $250 times).

E-minis are almost exactly the same as their full-sized counterparts, they just add the benefit of less margin required so they can be traded by less capitalized traders. Since their launch, they’ve become more liquid than their counterparts, with the S&P 500 E-mini being the most actively traded futures contract in the world.

Tick Size and Margin Requirements

E-mini futures don’t trade in sub-pennies the way most stocks do. They each have a minimum tick size, $0.25 for example, which is the tick size for the S&P 500 and NASDAQ 100 E-minis.

Here’s a list of popular E-mini contracts and their tick sizes and margin requirements.

Tax Advantages

The effective tax rate for futures trading is lower than stocks because of the IRS’ 60/40 rule for futures and non-equity options. This essentially means:

  • 60% of profits are taxed as long-term capital gains
  • 40% of profits are taxed as short-term capital gains 

 This is in contrast to short-term stock trading, where 100% of your profits are taxed as short-term capital gains. This can make a huge difference in a larger trading account.

Leverage

Stocks: 50% margin requirement

Futures: 10% margin requirement

Futures grant you access to more leverage than stocks and ETFs. Futures contracts typically require around 10% initial margin, meaning you can control $50,000 with just $5,000 of margin. This is in contrast to stocks, which require 50% initial margin, meaning control $10,000 with $5,000 of margin).

No Pattern Day Trader Rule

Undercapitalized traders are undoubtedly familiar with FINRA’s pattern day trader rule, which restricts traders with less than $25,000 of equity in their account from day trading stocks or options more than 3 times in a rolling 5 day period. (PDT) 

Futures don’t carry these restrictions. As long as you meet the margin requirements (outlined above), you can trade as often as you’d like.

How To Trade E-mini Futures

In practice, trading a futures contract is almost indistinguishable from stock trading. The main difference is one futures contract controls a lot of capital, generally tens of thousands of dollars. The typical share of stock is worth anywhere from pennies to hundreds of dollars. This can make a big difference to the day trader currently paying commissions on a per-share basis. 

If you’re coming from the stock trading world, it might be necessary to change brokerages. While most large brokers offer futures trading, if you’re going to take futures trading seriously, you should get a broker that specifically caters to futures traders. 

For the active traders, there is Tradovate. You pay a flat rate once a month and pay no per-trade commissions, outside of standard exchange fees. They offer a powerful platform featuring volume profile, depth of market, and order flow analytics.

E-mini Futures Trading Strategies

Market Profile

A market profile displays how much volume has been executed at each price, as opposed to a traditional volume histogram. A profile provides visual context as to where most supply and demand exists. 

Here’s an example of a volume profile. The bars on the side represent the quantity of volume done at each price:

Volume profile is a very popular tool in the futures markets used to implement a strategy based on the auction market theory. It’s important to note that volume profile itself isn’t a trading strategy, it’s only a method of organizing data. The implementation of auction market theory is where the strategy comes in.

The strategy theorizes that the purpose of a market is price discovery–to find a price where buyers and sellers agree. To do this, the market goes through a process of auctioning higher and lower to find a point of control, which is that point of agreement. In a broader sense, the value area is the range of prices where there is most agreement between buyers and sellers.

The red line in the chart below is the point of control.

Volume profile practitioners see the point of control as the ‘fair’ price for the asset. Buyers and sellers have overwhelmingly agreed to facilitate trade at that price most often. Based on this, many practitioners see significant deviations from the point of control as an ‘unfair’ price, so they’ll fade those moves.

For example, if the value area is between $98 and $102, and price trades up to $106.00 on low volume, that would be a standard short for a volume profile trader. This essentially comes down to a more holistic view of support and resistance.

Instead of viewing support and resistance as static levels, the value area and point of control act as a channel, with the top and bottom acting as resistance and support, respectively.

Trend Following

Trend following can be boiled down to the phrase “the trend is your friend.” Buy when the price is moving up fast, and sell when it’s going down fast.

Hedge fund manager Richard Dennis got rich from trend following in the futures markets using a simple strategy of entering trades on 20 or 55 day highs and lows. The strategy was so straightforward that not only did he get rich, but he made several inexperienced traders into millionaires after teaching them the trading rules. 

There are several types of trend following strategies. Most are essentially variants of Dennis’ new-high strategy: buying moving average crossovers, new highs, time-series momentum, etc. They all boil down to “the trend is your friend,” and buying when prices are increasing quickly, and selling when prices are decreasing quickly. 

Final Thoughts

Those who prefer to trade a small concentration of instruments–maybe you trade the same stocks and have learned them like the back of your hand–are perfect candidates to look into futures trading. They generally don’t make sense for the momentum day trader who is trading new stocks everyday.

Pros

  • Increased leverage.
  • More liquidity.
  • No PDT rule.
  • Tax advantages

Cons

  • Small concentration of instruments. Momentum equity traders have thousands of new opportunities everyday
  • Tougher competition. When trading small cap equities, there’s often another retail trader  or direction-agnostic fund on the other side of the trade. Futures are populated by the most capitalized and intelligent institutional investors.