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FUTURES TRADING 101: DON’T MAKE IT MORE COMPLICATED THAN IT IS

Danny Riley

I never knew where my first job on the trading floor was going to lead me. It was as a runner in the grain room at the Chicago Board of Trade (CBOT) making 70 bucks a week. It then took me into the bonds where I got to know Tom Baldwin, who turned $15,000 into $150,000,000. But my real calling was on the floor of the CME at 30 S. Wacker in the wildest contract in the world, the S&P 500 futures. 

BONDS TO S&P
I liked the bonds but they were too slow. On a good day the bonds would move a full point but on a slow day they would move less than 15 or 20 ticks. It was a whole different deal at the Merc (CME), and when I finally settled in and got a better handle on the price action of the S&Ps I knew I had found my calling. All the ups, downs and volatility was right up my alley. Economic reports would move the S&P in the morning and earnings would move them in the afternoon. It was nonstop action. I knew right away there was a big opportunity and within a few years of opening my desk it quickly became the largest S&P futures desk on the floor. We executed orders for some of the biggest names in the business, Moore Capital, Soros, Paul Jones from Tudor, AIG, Goldman prop, Bank of America, UBS, ADIA, the Saudi royal family and many others, all the way down to the little guy buying and selling 1- and 2-lots. It is also where I met my mentor, Marty “The Pit Bull” Schwartz.

DUAL TRADING
If you’re asking why these big accounts came to us, it’s simple. We didn’t fill the orders in the pit, we picked up the phones. We were the last line of defense against something called “dual trading,” a banned practice where a broker buys and sells for his or her own account while filling customer orders. That meant that the desk clerks were constantly at odds with the pit. The desk would be quoting one price and the order would be getting filled at a lesser price. This would cause big fights between the desk and the pit, and I am not talking about bumping chests. At one point we had 10 people working phones at the desk and fighting was a daily occurrence. So the answer to the question is that the business came to us because we fought on behalf of the customers.

RACING ORDERS
There were a lot of great traders on the floor, some very skilled in charting and market timing. Some scalped for a living, get in and get out, while others had a longer-term view. With big customer order flow, the order fillers and the locals flourished. We had an account that would trade 2,000 lots. Before the multiplier was cut, the big S&P was $50,000 per handle, 1 handle on a 100-lot equaled $50,000, 1 handle on 1,000 contracts equaled $500,000, a handle on 2,000 equaled $1,000,000. Today a 100-lot in the big S&P is $25,000 and 100 ESM per handle equals $5,000. So the old stories about traders making $200,000 or $300,000 or even $1,000,000 in a day are true. There were skilled traders that knew when to buy and sell, then there were your muscle traders that were always looking to trade off the “slippage” between the bid-ask and race a buy or sell order. They could take advantage of the inefficiencies of the marketplace and make tons of money. Those locals were gone for good when electronic trading came along.

NO MORE FREE RIDES
In 1995-1996 the CME did a swap. The MATIF gave the CME Globex and in exchange the Merc gave up its clearing systems, thus in came the age of electronic trading and bye-bye to unskilled floor traders. There are still a very low number of futures traders standing in the grain pits and in the Eurodollar and meats, but the numbers have dwindled down to only 5 or 10 in some of the pits. The S&P is the only pit that still has a local population. In its heyday there were over 450 locals in the S&P pit; today that number is down to less than 50 or 60 on a good day. These locals are what I call hybrids. They can bid and offer with their hands in the big contract or they can get in or get out by using a handheld to trade the ES. These locals do not make the big money like they used to; most are happy to make $500 or $1,000 a day.

Everything Changed
The migration over to electronic trading has cut out the front-running and slippage. A retail customer plays on the same playing field as a big hedge fund or bank. While electronic trading cleaned up dual trading in the pit, it also brought in another obstacle for futures and options traders -- program and algorithmic trading. Even the big funds know that when they enter a big electronic futures order to buy or sell, there is a robot stepping in front of their order. Many of the big trading shops now have algorithmic programs so they do not talk about it much, but we see it all the time when we buy 5,000 or 10,000 ES. As soon as we are done with the order the ES moves in the other direction. When I started doing the UBS program business in the S&P, program trading only made up 25% to 30% of the daily volume. We thought that was a lot back then, but today the practice makes up 60% to 70% of the daily volume. That does not leave a lot of room for the day traders who get whipped around every day by the practice.

Simpler Approach
In order to keep up, futures traders have to evolve. Things that we depend on for years no longer work. In the new world trading order traders are employing new systems and indicators to stay ahead of the game. Many times this complicates the game more than it helps. It adds cost and not all the changes make money in the end. This is exactly what we do not want to see. I have been on the floor for 35 years and only over the last 6 years have I felt a need to go back to the basics. Get out your chart, start drawing lines and employ your knowledge along with some practical advice from an old floor trader. The first part is the single most important rule of all and it’s called patience -- expand your levels, have a more forward look. Basic risk management, know your risk before you buy or sell. Build up some of your own daily trading rules. Write them down on a card and put them where you can see them all day. This is not the old open outcry pits, this is your money. Protect it.

MrTopStep Trading Rules 101
Many years ago I started to notice certain patterns that would show up in the S&P and sometimes in other markets. Most of our trading rules are basic in nature but if you follow them you will see how the patterns fit. This is not something that will happen overnight but some of the rules will come to fruition. Please open the MrTopStep trading E-book. http://mr-topstep.com/images/pdf/MTS-Trading-Rules-101.pdf Read the quick intro and go to Turnaround Tuesday. If you think we are kidding, Tuesday is not only the most winning day of the year -- up 15, down 3 out of 17 -- but it also has an average gain of 9.6 handles. Or the MrTopStep 10-handle rule, where we believe the S&P moves in 10-handle increments which tend to act as inflection points. Or the Pit Bull’s rule called “the Thursday/Friday low the week before expiration.”

I think it’s fair to say that the only thing that makes money every day in the futures markets are your brokers and the kid down the street’s algo. There is no magic carpet. Only by employing proper trade management and working a daily trade plan can you survive. MrTopStep trading rules are a common-sense guide.

mtsop-05142013-netchanges

Our view: There have been a total of 18 Tuesdays this year, 15 up / 3 down. Total average gain +9.6 handles, total average loss over the 3 down days is -3.9 handles. 81 trading days into the year the Fed QE3 + continues to drive stocks higher. We lean to selling the early rally and buying weakness. As always, keep an eye on the 10-handle rule and please use stops when trading futures.

  • It’s 7:15 a.m. and the ESM is trading 1634.25, up 3.5 handles; crude is down 24 cents at 94.93; and the euro is up 5 pips at 1.2978.
  • In Asia, 7 out of 11 markets closed lower (Shanghai Comp. -1.11%, Hang Seng -0.26%, Nikkei -0.16%).
  • In Europe, 7 out of 12 markets are trading higher (CAC +0.01%, DAX +0.44%)
  • Today’s headline: “S&P Futures Lower After New Record High”
  • Total volume: 1.32mil ESM and 6.4k SPM
  • Economic calendar: Charles Posner speaks, NFIB Small Business Optimism Index, import/export prices, Redbook and a 4-week T-bill auction.
  • Fair value: S&P +2.53, NASDAQ +3.16
  • MrTopStep Year To Date S&P 500 Net Changes: http://mr-topstep.com/images/2013/May/mtsop-05142013-netchanges.jpg
  • MrTopStep Closing Print Video: https://mr-topstep.com/index.php/multimedia/video/latest/closing-print-5-13-2013

Danny Riley is a 34-year veteran of the trading floor. He has helped run one of the largest S&P desks on the floor of the CME Group since 1985.

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DISCLAIMER: The information and data in the above report were obtained from sources considered reliable. Opinions, market data, and recommendations are subject to change at any time. Their accuracy or completeness is not guaranteed and the giving of the same is not to be deemed as an offer or solicitation on our part with respect to the sale or purchase of any commodities or securities. MrTopStep, its officers, directors and its contributors may, in the normal course of business, have position(s) which may or may not agree with the opinions expressed in this report. {jathumbnailoff}