I thought that this might be a good video to watch as I had to scramble a bit to salvage a gain from the trade.  The darn thing almost stopped out for a gain three of four times but stopped one tick short.  I finally had to move my stop up to 7 ticks as the market started to consolidate and I worried that the trade would go south.  It was a pretty interesting trade and I actually had to think a little as the trade played out.  Did I do the right thing?  Let me know what you think.

It garners more trading volume than any emini contract on the Chicago Mercantile Exchange, and has run away (in trading volume) from any other futures contract currently traded.  It the pint sized version of the S and P contract that traders have flocked to in recent years.  Better yet, it is specifically designed and priced for the individual trader.  What’s not to like?

I spend a decent amount of time in trade rooms, helping novice day traders develop their trading style.  One thing I have noticed, especially among the novice day traders, is their lack of awareness of exactly what they are trading.  So I thought I would write an article that gives the very basics of the ES contract.

What is the S and P 500?  You would be surprised at how many traders can’t definitively answer this question.  The S and P 500 is a capitalization-weighted index of the 500 largest, publicly traded, large-cap stocks in the United States.  The index has been around since 1957.  The index is calculated and published by Standard and Poor’s, hence the S and P in the title.  Incidentally, the index reached it’s highest point in March, 2000 at 1552.87.  In 2010, it was trading in the 1100 range, a far cry from it’s apex.

The ES emini contract was established on Sept. 9, 1997, and has grown steadily since that date.  Some specifics on the contract are:

1.  The contract months for the ES are
a.  March         =H
b.  June            =M
c.  September  = U
d.  December   = Z

Notice the contract months are designated by letters, and the contract designation is calculated by combining the letters with the ES designation, the month, and finally the last number of the year.  For example, ESM0= the ES contract for June in 2010.  Once you trade the ES for a period of time this nomenclature becomes second nature.

Many have been confused by the pricing model used for the ES contract.  It is fairly simple.  The ES emini is one fifth the value of the traditional S and P contract, so each point is worth $50 dollars, as oppose to $250 per point on the big contract.  Each point is divided into ticks or one fourth point, or $12.50 per tick.  So, 4 ticks at $12.50= $50.

The contract expires at 8:30 a.m. on the third Friday of contract month. (March, June, Sept. Dec.)  It is fairly normal for traders to have abandoned trading the contract about two weeks before the expiration.  Most futures brokerages  announce the date of switch over to their clients, so there is generally not the confusion that you might expect at contract expiration.  If you are a day trader, it is imperative that you switch to the new contract prior (preferably the above mentioned two weeks) and not trade the ES emini right up to expiration.  Most of the volume evaporates from the contract on the switch date, and you could run into having make good delivery of the full delivery requirement of the contract.

The clear advantage of the ES emini contract is the tremendous liquidity, and thus you should never see slippage as a result of the contract trading thin.  More than a million contracts are traded on an average day, which is astounding volume when taken against some of the thinner emini contracts offered.

The ES emini contract on the Chicago Mercantile Exchange, which has been a true innovator in the emini arena.  The CME Globex is the actual home of the contract, and it trades during regular trading hours, takes a short break, and then trades all night until the opening of the next days cycle.  The actual hours of trading are:

Monday-Thurs  5:00 p.m.-3:15 p.m. & 3:30 p.m.-4:30 p.m.
Sunday              5:00 p.m.-3:15 p.m.

Margins requirements vary by firm and whether you are trading intraday or holding contracts overnight.  For inraday traders, you can find margin requirements as low as $400/contract and as high as $3000/contract.  Of course, the lower contract margin requirement may tempt some traders into over trading their futures account, and this can be a real problem.  In any event, the contract margin requirements vary greatly.

As you can see, the ES emini contract is a versatile and popular equity trading instrument.  We have reviewed the monetary basis for the contract, as well as the calender specifics for trading.  We have pointed out the margin requirements and trading hours, now all that is left is for you to perfect your trading style and enjoy trading this flat-out-fun trading instrument.

It doesn’t matter.

As a trader I am only interested in what the market does, not why it exhibits certain tendencies.  I realize that is a bit of an obtuse answer, but it is one I have learned to live with comfortably.  Of course, it is often discussed among traders and each day trader has his opinion, but to trade the markets it is not necessarily important why this phenomena occurs.

On the other hand, some days the market pays absolutely no attention to pivot points and goes along its merry way without stopping at any particular point on the chart.  More often than not, though, the market will stop at the pivot points, or pause , or reverse right at the plotted lines.  My point is a simple one; pivots are very useful, except when they are not useful.  Whether the market will adhere to the predicted support and resistance is something that you must glean from watching the price action for a bit.  I typically don’t initiate my first trade of the day based on pivot points.

The formula for calculating the days support, resistance, and pivot point is as follows:

R2 = P + (H – L) = P + (R1 – S1)
R1 = (P x 2) – L
P = (H + L + C) / 3
S1 = (P x 2) – H
S2 = P – (H – L) = P – (R1 – S1)

S=support levels
R=resistance levels
H=hi
L=low
C=close

As you might have surmised, the formula plots five lines on your trading chart.  These lines are commonly referred to as S1, S2, PP, R1, and R2.  S1 and R1 are the first lines of potential support/resistance on your chart.  The pivot point is the primary line of support and/or resistance.

Most traders have their own set-up to trade pivots, and I have three that are favorites of mine.  One is a break out through a resistance/support level.

Break outs often time occur when the market is in a consolidating mode and forms a horizontal channel, with the price banging off the top and bottom of the channel, especially if the channel is on a support/resistance line, as is often the case..  After this price action continues for two, maybe three cycles, I will set a sell a point below the channel and a buy a point above the channel. (I am referring to the ES contract here)  Generally the price action will break out of the channel and continue in the direction of the break out and you pick up the trade as it blasts through the channel parameters.  This is a pretty good strategy and can be very profitable.

Breakdowns are also a great way to use your pivots.  This trade is especially good if the market has been hitting a support/resistance line and stopping.  As the price action approaches the support/resistance line, I will set a buy one point below the line in hopes of picking up the trade as it pierces the line.  This trade can be a bit dodgy, especially if the market has been bouncing off the lines all day because the earlier bounces were usually followed a move in the other direction.  Your hope is that the move does not go through the line a bit (as it often does), pick up your trade and change directions.  Again, here you can set your order lower, maybe 1.5 points below the line if you are uncomfortable.

Finally, you trade the pullbacks from R and S.  Let’s say the market pierces S1 and heads straight to S2 and stops and reverses.  Often times the change in direction will go straight to S1 again, retracing it’s move down in the opposite direction.  Once it reaches S1 I will set a trade 1 point below S1.  More often than not, the trade will hit S1 and reverse field to the short side, and if it continues upward you stayed out of the trade by virtue of setting your sell 1 point below S1.  This probably my favorite pivot point trade, and comes with a higher degree of safety than most.  Of course, no specific trade works every time.  If I am stopped out twice on a pivot point trade, I forget pivot points for the rest of the day.

In summary, we learned that pivot points are predictors of future activity.  Further, as predictors they may or may not be effective on a given day of trading.  Your power of observation is key to understanding the effectiveness of a pivot point every trading day.  We reviewed three basic trades that I use; the breakout, breakdown and pullback.  If you learn to combine your trades with an oscillator or a tick chart, you will develop and even higher degree of activity in your trading.  Remember to check yourself when trading pivot points, never trade without stop-loss orders in place.

Let’s take a moment and talk a little about a strategy for entering trades.  We will assume you have identified a potential trade to the short side and are ready to take that trade.  Instead of putting a straight market order in place and buy at whatever the market is trading at when your order is filled, why not set your short entry several ticks above the current market price and let the market come to you?  Granted, you run the risk of missing out on the trade if the price dive bombs straight down, but that is a rare occurrence.  Even in a trending market, the price tends to bounce around and you are likely to get filled at your buy order above the market price.  You just saved yourself a half point.  You can look at your Average True Range Indicator to see how the range of the market has been and base your entry, to a certain degree, in a manner within the range.  In dead flat markets, though, this may not be such a good strategy.  Then again, I am not very excited about day trading flat and choppy markets anyway.

Now let’s talk a bit about scaling out of a trade.  If you have read any of my articles you know that I usually have a specific profit target in mind and a specific stop loss point.  In this example I am going to trade 3 contracts and my profit target 15 ticks on the ES Emini contract.  On a day trade like this one I will generally scale out of the trade.  A good trading platform will allow you to set specific strategies for selling at different prices.  I use Ninja trader, and I can preset my exit strategy as follows:  I am going to sell 2 of the contracts at 10 ticks profit and 1 contract at the 15 tick profit target I had in mind.  You can use any variation of selling strategies you feel comfortable with and most good day trading platforms allow up to 3, sometimes 4, separate levels to scale out of your trade.  You can preset these strategies and name them in a manner which will allow you to choose which one you are going to use simply by clicking on the strategy you will employ.  For example, this strategy on my platform I named 3x10x15.  It’s my own nomenclature, but I know this means 3 contract with exits at 10 and 15 ticks.  I generally exit a larger portion of my contract on the first exit to lock in a nice profit and let the last contract run.  I can even move the stop on the single contract if I see a market start a sharp move in the direction I am trading.

One of the maxims I live by is to never let a winning day trade become a losing trade, and scaling out of a contract is an excellent way to assure you lock in a nice profit while allowing yourself the latitude to let a contract run.  Needless to say. there are an endless number of potential scaled exits you may employ.  In my trading, and I cannot fully explain why, I tend to trade an odd number of contracts and lock in the majority of my contracts at the first exit point, then manage the remainder of the contracts as the trade develops.

Entering a trade in the proper fashion and scaling out of the trade is an idea you may wish to employ in your trading, especially if you are trading out of fear.  (on the other hand, if you are trading overly fearful, it might be wise to take a break from trading and regroup)

On single contract trades I generally just bracket trade, as no scaling is possible with a single contract.  Try buying at the price you want with the method above and scaling out of a trade and see if it doesn’t prove to be a profitable strategy for you to employ.  It does give you a bit more control of the trade, and incrementally lowers the risk in the trade.