Every day trader must decide which financial instrument to trade. There are many choices including futures, forex, stocks, and options. There are also many considerations of your own, and conflicting advice from your friends. Indeed, it is a difficult choice to make.
Let’s cut the chase and tell you why futures trading is the best option for a day trader.
Profit from your analysis with futures trading
Futures move in tandem with its underlying asset.
Futures and options are two derivatives used by active traders.
For options, we analyze the underlying asset but trade the option. This discrepancy is a problem because while we analyze the underlying asset, our profit and loss are not directly linked to its movements.
Instead, our profit and loss depend on how option prices move. However, due to factors like time value and volatility that affect options pricing, it is possible that the option prices do not move in tandem with its underlying at times.
Very often, the underlying asset might move as you anticipated, but the price of the option does not budge.
At times, it might even move a little in the opposite direction. This phenomenon is especially common in short trading time-frames. Your analysis is right, but you are not rewarded. This problem affects day traders who want to extract quick profits from the market.
On the other hand, futures move in tandem with its underlying asset. Traders apply technical analysis tools on the futures market directly. This allows us to profit from our anticipation of price movements without the complications of derivative pricing.
Futures has no restrictions on short-selling.
There are no restrictions on shorting in the futures market.
A day trader’s job is to take only the best trades, regardless of whether it is a long or short trade. With the unfettered ability to take on long and short positions, a day trader can stay neutral and act according to his or her current market analysis.
The stock market is different.
Although day traders can short-sell stocks, they are still limited by the shortable shares offered by their brokers. (You need to borrow a stock through your broker before you can sell them to profit from a bearish move.)
Moreover, financial regulators all over the world frown upon short-selling. Although short-selling bans do not solve fundamental problems of the stock market, regulators have used short-selling bans on many occasions as a short-term solution to prevent stock market collapses or perceived manipulation.
Free your trading capital
FINRA’s Pattern Day Trading Rule does not apply.
According to FINRA, you are a Pattern Day Trader if:
- You use a margin account; and
- Day trade the same security for more than four times within five business days; and
- The day trades form more than 6% of your total trading activity for the same five-day period.
And if you are a Pattern Day Trader, you must keep up at least $25,000 in your trading account to day trade.
It is challenging for a day trader to avoid the label of Pattern Day Trader. Of course, you can trade very infrequently, or use a cash account. Both are not ideal solutions and impede the goal of a day trader.
Day traders want to take the best trades, even if the best trades occur more than four times within five business days.
Day traders want to make the most out of small intraday swings and using a margin account for leverage is essential.
Those are the bad news, at least for stock and options traders. The good news is that the Pattern Day Trading Rule does not apply to futures traders.
Futures traders can have less than $25,000 in your account and still day trade to your heart’s content. (Subject to your rigorous market analysis, of course.)
Day traders can make use of lower initial margins for futures trading.
To enter a futures position is to open a contract to buy or sell. You are not buying or selling anything, yet. So you do not have to pay.
However, you need to post an initial margin (also known as the performance bond) as a guarantee of your ability to fulfill the contract. The amount of initial margin depends on the product and market volatility.
While the futures exchange set the initial margin for overnight trading, futures brokers are free to decide on the initial margin for intraday trading. The difference is significant.
For instance, the initial margin for the E-mini S&P futures (ES) traded on the Chicago Mercantile Exchange is $6,930 per contract (as at 13 May 2019), while many futures brokers offer day trading margins as low as $500.
For day traders, this means that you can trade one ES contract for every $500 in your futures trading account. Given the size of one ES contract is $50 x S&P 500 Index (now at around 2881.4), you are controlling a value of about $144,000 using only $500.
A note of caution: Low day trading margins is not a reason to take on excessive day trading risk. Your position size should still be determined by a sound model based on the expectancy of your day trading strategy and your risk capital.
However, you can make use of the lower margins to manage your trading capital more efficiently.
Feel safe trading futures
There is central clearing for futures.
As futures are contracts, they are technically exposed to the risk of contracting parties failing to act according to the contract terms. This risk is known as counterparty risk.
However, futures are traded on the exchanges, and the exchange clearinghouse is the counterparty to both sides of the contract. With daily marking-to-market and performance bonds pledged to the clearing members, the counterparty risk of futures contracts is almost zero.
On the other hand, many retail spot forex brokers are market makers.
When you buy or sell forex, your broker sells or buys it from you. If your broker is unable to fulfill the deal, which is possible, especially for small forex brokerages that are not well-regulated, your paper profit is worth less than the paper it is written on.
Volume data for futures contract is reliable.
An advantage of having central clearing is that you can get reliable trading volume data.
The volume reflects the interest of market players and is useful for technical analysis, especially volume spread analysis. You can trust that your volume analysis is meaningful.
Getting reliable volume data from your forex dealer is impossible. This is because spot forex trading is decentralized and no one dealer has all the information.
Futures Trading is the Best Option For Day Trading
To summarize, this is why futures trading is a day trader’s dream.
| Futures | Spot Forex | Equities | Options | |
|---|---|---|---|---|
| Move in tandem with the underlying asset | Yes | Not applicable | Not applicable | Not always |
| Can take on a short position easily | Yes | Yes | No | Yes (using puts) |
| Can day trade without restrictions | Yes | Yes | No | No |
| Greater leverage for day traders | Yes | No | No | No |
| Central clearing | Yes | No | Yes | Yes |
| Reliable volume data | Yes | No | Yes | Yes (but not useful for analysis) |
If you are a day trader and had chosen not to trade futures for some reason, we would like to hear from you!
Share your views with us by commenting below.
Image credit: liz_noise [CC-BY-2.0], via Wikimedia Commons
Guys, I have generally avoided day trading futures because i feel it is so competitive. With smallcap equities, at least you are not competing against sophisticated algorithms. Some stocks can also have more predictable moves based on specific news events whereas macro indices can be quite capricious. That said, I have never traded futures and would be interested to hear of anyone who makes money scalping weekly on a consistent basis without significant drawdowns. If it is possible, then I agree futures are the better option.
It seems the only futures strategies that can provide consistent returns are buying/scalping pullbacks into the intraday trend. But I just have a suspicion that the profitability of that is declining every year.
Thanks for sharing your experience, Steve. I meant to highlight the objective features of each instrument with regards to day trading (i.e. restrictions, leverage, ease of shorting etc). As for the trading methodology that provides an edge in each market, that’s something we have to work out ourselves by studying the markets.
I have discovered my own day trading strategy and futures can be useful but there are many details that need attention. Some futures brokers such as Td Ameritrade require 15,000 minimum account for intraday margin. Info. is hard to come by for sure. Ninjatrader for example is not user friendly and requires weeks, if not months for a learning curve just to set it up.
Another issue with day trading and leverage is using bracket orders which is great. But what happens if the order is sitting on the computer to close the trade and you are already in it, but you lose connection? That could turn into a real nightmare. So is web based better, being its sitting on a server somewhere else?
Its a shame but there is much to learn and very few have the experience, also the brokers are of little help.
Your concerns are valid, and they highlight the importance of researching information for yourself before deciding on your preferred market. The information tends to vary according to your country, broker, and platform. Clarifying the details is critical and takes time. As for your concern with losing connection, you can check out this page for more details with respect to NinjaTrader.
Does options on the Futures, count toward the Pattern Day Trader rule?
I see there are options on /ES (E-mini SP futures)….
TY
I’ve not traded options on futures in a while, but from what I can remember, there are no restrictions on that. But you should definitely check with your broker to confirm.
I have a question about how many trades I can take in one day with futures. Lets say I have a $50,000 account with a broker that requires an initial margin of $500 to trade Emini S&P futures. Lets say that everytime I enter a trade, I always buy 6 contracts, so I need an initial margin of $2,500. Also, its a RT trade so I am not having multiple positions open at the same time. Everytime I open a position, I close it before I enter a new position. Does this mean that I can only take 20 trades per day at max since ($50,000/$2,500 per trade)= 20 trades? Or does this mean I can take as many trades throughout the day as long as I have $2500 for the initial margin?
If you buy 6 contracts, you will need $3,000 as your initial margin. Typically, you can take as many trades throughout the day as long as you have a sufficient amount for the initial margin before you open the trade. However, I strongly recommend that you have a wide margin above that to deal with drawdowns. Use day trading margins with caution as it involves huge leverage. Finally, you should direct these questions to your broker to make sure this is exactly what they are offering.
My broker says I need 3 years of trading experience before I can trade futures. Is that true for the index futures like e-mini SP? Does that seem right?
Yes, if your broker states that requirement, it should hold true for all futures including E-minis. It’s due to the leveraged and more complex nature of futures.
Which broker is this? Are there preferred brokers that do not have this requirement?
I have a 1 million $ + account with TD Ameritrade. I am authorized to trade futures contracts but I do not as it seems like flipping a coin day trading. In my regular TD account I am not diversified at all and stick pretty much to oil stocks & ETF’S both long & short.. I do, however stay on top of Energy data, news etc. One of the major Chicago brokers calls me almost daily to open a futures account with them, and I am tempted to do so. He says my past experience with oil & gas equities gives me an edge and that may be true, but I still feel it is like Russian roulette and sooner or later Boom! I think I am leaning toward saying NO to him and just stay in my comfort zone of selling short puts, deep out of the money, when the underlying are in lower support & IV is high. I have been successful in Betting where a stock/ETF will not drop to and even it does, and I get assigned I have been paid to buy it low. I don’t want to miss out more opportunities but knowing about 90% of new futures traders lose money, why would I be an exception??
It sounds like you have a solid strategy going on with options as a volatility seller. If that’s the case, futures is a whole other game. I think you should stick to your verified edge here. And if you’re really curious about your profit potential in the futures market, you can definitely start small and see if your current approach works for futures trading before thinking of scaling up.