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Tharp's Thoughts Weekly Newsletter

July 17, 2008 — Issue #381  
  
Workshops

Germany Workshops

Article

E-Mini Futures Watching by D.R. Barton

Updates

Addition to the Fall Workshops in the USA

Trading Tip

Oil and Gas – Crudely Speaking Part IX by D.R. Barton

Melita's Corner

Celebrating Life by Melita Hunt

Coming Soon

Van Tharp in Germany in Less Than 3 Weeks

 

Blueprint for Trading Success August  4-6 Germany
Peak Performance 101 August 8-10 Germany

Click here for workshop information, pricing and hotel information

 

Feature

E-Mini Futures Watching

by
D.R. Barton

I believe that e-mini index trading is the most potent way that a trader can use their trading capital today, especially when using the right tools, strategies and mental approach.

I was explaining this to a friend who was asking about all the monitors on my desk the other day.  And about 30 seconds into my description, I realized that I was describing things that most folks might not be familiar with.

It was like the conversation I had with my 16 year-old daughter, Meg, this week.  She was reading a book, and I asked if it contained short stories.  She informed me that they were essays.  Being a few years removed from high school, I asked her to remind me of the difference.  She said that essays are like – um, essays and short stories are really, well, short stories.

Meg is such a literary wizard (e.g., perfect score on the reading section of the national PSAT test), that the difference between an essay and a short story is second nature to her.  But she quickly gathered her thoughts and explained that essays are just a discussion of a topic and that short stories have a plot.  Okay – now I get it.

So before delving too far into the topic of e-mini index trading, I thought it might be good if we covered the basics.  Then we’ll look at some great things that are happening in those markets now.

The E-Mini Index Basics

In the futures trading world, e-mini index futures have grown into quite a phenomenon.  They have experienced growth unlike any other instrument, and for good reason.  But let’s start with a very basic overview.  E-mini contracts were started by the Chicago Mercantile Exchange (CME) in 1998 with the S&P 500 e-mini.  It currently is worth 1/5 of the larger, pit traded S&P futures contract.

However, for the reasons we’ll discuss next, the S&P e-mini has far eclipsed its older and higher-valued sibling.  As of the first quarter of 2007, the S&P e-mini was trading 4.5 times the dollar volume of the large S&P 500 contract. Today, the e-mini trades more than 10 times the volume of the pit traded contract!  There are many reasons for its popularity.  Here are just a few:

·    The e-mini contract is traded electronically on a platform called Globex. 

·    Trades are executed instantaneously and are basically error-free, especially relative to the pit traded contracts that may require several levels of human interaction before orders are executed.

·    The smaller size and therefore reduced margin requirements of the e-mini contracts allow a high degree of retail participation.

The immense popularity of the S&P e-mini has led to a number of other equity indexes trading electronically in the e-mini size.  The most popular among traders are the Nasdaq Composites,  Dow Industrial, the up and coming Midcap 400 and the Russell 2000.  E-mini trading has also spread to commodities (gold, oil), bonds and currencies.

Let’s look at why traders love these instruments so much.  After we review these attributes, we’ll talk about what’s happening now in the world of e-mini trading.

·  Leverage.  One of the biggest advantages for e-mini trading is the high amount of leverage they offer.  And for day traders, this leverage is increased still further.  Let’s look at the actual leverage available:  the S&P e-mini trade unit is $50 times the S&P 500 Stock Index.  Currently, that calculation looks like this:  $50 x 1240 = $62,000.  The margin to control $62k worth of stock is around $4,500 giving you leverage of about 14:1 on your money.  However, the day trading margins are dropped significantly with $1,000 margins common and some reputable firms offering $500 margins.  At these rates, you can increase your intraday margin to greater than 100:1!

But leverage is a double edged sword that definitely cuts both ways.  While such leverage allows for large returns on very little money, it can also mean that you can lose large amounts as well.   In Part II of this series,  we’ll cover tools that allow us to use this leverage in a big way, while protecting our downside.

·    Liquidity.  Liquidity is usually thought of in terms of volume, and it is the characteristic that gives us the ability to get in and out of trades both quickly and at a preferable price.  E-mini index trading gives us exceptional liquidity and great fills with little slippage.  And these attributes are very necessary to allow us to take advantage of the available leverage.

·    Scalability.  There are certain types of trading that can only be used on a small scale and cannot be translated to larger volumes as success occurs and larger position sizes are required.  But e-mini index trading in general and S&P e-mini trading in particular are highly scaleable.  Getting virtually no-slippage fills on 200 S&P e-mini contracts is an extreme advantage.

· Round-the-clock liquidity.  The S&P e-mini has liquidity 23.5 hours a day, which gives another advantage – the effect of overnight gaps are greatly reduced.  You can keep a stop in the market if you’re doing a swing trade and have your protection kick in at a time when your IBM stock is still sleeping.

The last item to talk about is great volatility that has been in the broader market in general and the S&P e-minis in particular.  The Average True Range (a measure of daily range that takes gaps into account) for the S&P e-minis has been above 20 points per day for the last 12 months – with only one period last fall where volatility contracted.  This has provided good opportunities and a great trading environment, especially for day traders.

In Part II of this article we’ll look at some specific tools and strategies that top e-mini traders are using today to take profits in these markets.

 

 See more about D.R. below following his trading tip. 

 

Updates and Additions

Fall Workshops in the USA

September 20-21-22 Peak Performance 101
September 24-25-26 Advanced Peak Performance 202
October 11-12-13 Blueprint for Trading Success
October 15-16-17 ETF and Mutual Fund Techniques 101
November 7-8-9 How to Develop a Winning Trading System That Fits You
November 10-11-12-13 Super Trader Workshop 
(for current members and graduates only)

Trading Tip

Oil and Gas –Crudely Speaking Part IX – Socialist Barbarians at the Gate

by
D.R. Barton

In the short-run, the market is a voting machine; in the long-run, the market is a weighing machine.  --Benjamin Graham

The insanity continues.

Let me start by saying that I don’t like paying $80 to fill up the family people hauler either.  And I travel a bunch by air, so escalating ticket prices are not fun. And I’m not thrilled that the value of our house ain’t what it used to be.

But when the free market is attacked from all sides during a downturn, I get really frightened.  (As a quick note-- I’m not a Libertarian, though I do support much of their smaller government, personal freedom, and free market issues).

This whole article won’t be a political rant — we’ve got some market stuff to talk about — but a confluence of governmental maneuvers is threatening to set horrible precedents.  I’m always concerned when there is governmental intervention in market activities.  Because it always costs us (consumers and taxpayers) in the long run.  Here are three recent items that have come across the radar screen:

1.                  Fannie Mae and Freddie Mac bailout.

2.                  Short selling curbs for financial stocks.

3.                  Airline execs and others asking for limits on oil trading.

I’d like to address each of these and then wrap up with some analysis of what’s happening in the oil markets.

Fannie Mae and Freddie Mac bailout.  No rant needed here.  The horse is already out of the barn, as they say.  If any legislation was needed, it was when the mortgage machine was leaping to lend money to anyone with an expired fishing license for a house worth five times what they could afford.  That worked out just fine – as long as real estate prices kept rising at astronomical rates.  Many of those infamous subprime mortgages would not even work if prices leveled off.  And let’s not forget, many homeowners and almost all of the institutions involved in the mortgage and homebuilding industry made HUGE amounts of money for many years when things were going well. 

But alas, a downturn came (as they ALWAYS do), and highly leveraged, underfunded plans no longer worked.  So companies and individuals who made lots of money when the going was good, got hammered.  They took big risks and now taxpayers have to bail them out. 

There is only a relatively small chance that Fannie and Freddie will actually fail.  But if they do, as one article put it, our national debt will double overnight.  If only regulators had the foresight to take massive action when all of those high-risk loans were being written instead of after the pain became intense…

Short selling curbs for financial stocks.  Does this seem like the “old boy’s network” to anyone else?  The SEC, along with Department of the Treasury and the Federal Reserve decide to curb short selling in Fannie Mae and Freddie Mac.  Oh yeah, almost as an aside, they also put the same curbs on short selling the stock of 17 other financial firms like Goldman Sachs, Lehman Brother, Merrill Lynch and Morgan Stanley.  Talk about the fox guarding the hen house!   And worse yet, this is another severe blow for free markets.

When a southeast Asian country outlawed short selling on their exchange, they were seen as reactionists who didn’t understand how markets work and were driving their country’s economy backward.  Ditto that for the folks who want us to think that short selling is the problem.  (I can assure you that not one of those astute guys and gals believe that short selling is the real issue.)  We have a whole industry that made a massive error.  They profited massively from their high risk strategies during the good times (remember the reports of Goldman Sachs bonuses being an AVERAGE of over $600k?).  But now when we see that these highly leveraged strategies could not be unwound quickly enough when the tide turned, everyone hides behind the regulators.  Limiting legitimate short selling disrupts the balance of the markets; there’s no way to legislate ever-increasing stock prices!  In fact, this is a risky move; there are studies that show down moves are more severe when short selling is limited.  This is because there is little way for stock prices to proceed down in an orderly fashion if there is not a two-way market.  Then when enough share holders are concerned, there is a mass exodus and a disorderly drop.  Time will tell if this comes back to bite the companies that seem to be getting temporary protection…

Airline execs and others asking for limits on oil trading.  I have a proposal for airline companies: let’s limit the amount of your companies’ stock that can be purchased to only those people who will attend the annual meeting and vote on governance issues.  Because that’s what the airline companies want to do with the oil markets.  Seems to me they wouldn’t like limits on their stock prices…

I’ll say here that I believe the airline business is one of the toughest around – huge amounts of competition, large capital costs, big labor costs – and then there’s fuel.

But to write an open letter to customers asking them to take action against oil speculation?  That sounds like desperation.  (Thanks to David Meyer for forwarding the United Airline letter to me.)

Yes, trading volume and speculation have increased in the oil markets.  It seems that people want to make money by buying stuff that’s going up in price.  I think they call it trend following.  Shouldn’t hedge funds and institutions be able to put their money where it’s being treated best?   The argument that the markets are being moved by “speculators” who have no intention of taking delivery of oil, is absurd.  More people would buy airline stocks if they thought the price would go up!  (That’s a low blow to industry that has plenty of struggles – but it is true).  And yes, individuals and institutions often (usually or always) buy stocks purely to make money, not because they’re interested in being involved in the governance of the company.  Some people buy condos never intending to live in them – they just want to make money if the price goes up.  Others buy collectible NASCAR plates or stamps for the same reason -- to make money on price appreciation. 

Billions of people across the globe are starting to consume more oil-based products and energy.  Gas and jet fuel prices have gone up.  Everyone would like something to be done about that.  The bad news is this – there may not be much we can do.  If I want that cool bright red and burnt orange throw rug on Ebay and three billion people are willing to bid more than I paid last year, I can’t exactly tell the seller to give it to me at last year’s price.  I have to pay the market price or not get it.  China and India are aggressively bidding for oil, both in private deals and on public exchanges, so they can meet their energy needs.  Individual and institutional speculators want to take advantage of that trend – and they should be allowed to do so.

And now a quick look at what the market is doing.   Here is a look at an interesting chart from two weeks ago:

You’ll note that we’ve crossed three of those “slope acceleration” lines that I drew.  But there are key support levels at ~131 and again in the 120 zone.  It’s interesting to note that just at the point where the whining about oil prices reaches a crescendo, oil prices are breaking down, at least a bit.  My prediction: more volatility and a market that’s tougher to read than a Thomas Hardy novel on two hours of sleep…

Please keep those comments coming to drbarton “at” iitm.com.

Great Trading!

D. R.

About D.R. Barton:  A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena.  He is a regularly featured guest on both Report on Business TV,  and WTOP News Radio in Washington, D.C., and has been a guest on Bloomberg Radio. His articles have appeared on SmartMoney.com and Financial Advisor magazine. You may contact D.R. at  “drbarton” at “iitm.com”. 

 

Melita's Inspirational Corner

Celebrating Life

by
Melita Hunt

I was watching a TV program the other night about a young lady who had survived two heart attacks at the age of nineteen and was now a spokeswoman for the heart foundation. One of the comments made by the host was “You have survived two heart attacks, so you should really be celebrating life now” and it surprised me that those words were said. Wasn’t she supposed to celebrate life before she had these problems?

I put it into context in my own life, should I be celebrating life now because cancer hasn’t killed me? Am I lucky to be alive? And I thought that this was stupid. I feel very blessed that I have, and always will, celebrate life. Celebrating my life isn’t something new for me, and I certainly haven’t had any profound moments about life now that I’m dealing with these current unfortunate circumstances. I have heard that people completely change their lives around and have huge “aha” moments when they are faced with difficult circumstances. Personally, I don’t fall into that category, I haven’t had any major “aha” moments in the last ten months. Perhaps they are reserved for people who haven’t appreciated and celebrated their lives?

So where do you stand on the celebration of life topic? Do you feel that you are making the most of your life and enjoying every moment? Do you love what you do and truly enjoy being around the people that you hang out with?

My life is made up of moments and memories that I consciously create, and I truly enjoy creating these moments and memories for myself and my family and friends. I know the things that make me happy and fulfilled (one of them is travel), and I endeavor to always do these things as often as I can. In the short time that Mum was here in the States with me, we took trips to New York, Asheville and Las Vegas. We visited fun places, took in the sites, went to shows and just loved and appreciated each other's company. Even though I was unwell, we still chose to do some of the things that we love to do, to the best of our ability, in the moments that we had.

Even when we are just at home in Sydney, we hang out together and have fun. Isn’t that what life is all about? When this life finally ends, either for you or for someone else, isn’t it specific memories and moments that we hold onto to?

So are you creating them consciously? Or is life just happening each day and slowly passing you by without any fun and celebration? Do you get stuck talking about doing the things that make you happy or are you actually doing them? Do you have one-day-itis? (i.e. I am going to do that “one day.”) Or are you proactive participants in your life, making sure that things happen that bring you joy?

Don’t wait for an “aha” moment to occur or bad circumstances to wake you up. It is time to grab hold of life and choose whatever it is that makes you happy. Then do it. We’re only here for a short time, and that becomes even more apparent as the years fly by. So let’s choose to create and enjoy every moment. Wouldn’t you prefer to be known as someone who celebrated life?

Melita Hunt is the CEO of the Van Tharp Institute. If you would like to keep up with Melita’s progress regarding her recently diagnosed lung cancer (she is a never-smoker). Please feel free to read her blog at www.myleftlung.com. You can contact Melita at mel@iitm.com

 

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