Is the Mini Dow A NEW CONTENDER?

Trading the markets is the greatest job in the world. There are no bosses offering contradictory instructions and, even better, no employees to baby sit. Each year thousands of people flock to the markets like lemmings to the sea. Yet, many fewer than that manage to avoid flinging themselves over the proverbial cliff. How does a trader break away from the herd and ease into a consistently profitable trading routine?

The key to staying profitable consists in online futures trading is sticking to the following four concepts:

• Staying in the right frame of mind
• Finding the best market to trade;
• Keeping on the path of least resistance; and
• Knowing what to do when things go wrong

Further on in this article, we will look at a very easy and potentially very profitable Chicago Board of Trade's (CBOT) online futures trading: mini dow. But before utilizing this or any strategy, a trader first must create the optimal mindset for online futures trading. This is very similar to the chicken-and egg theory: Without a professional state of mind, a trader simply cannot produce consistent profits over the long haul. In a similar vein, without that egg, Kentucky Fried Chicken would be nothing more than a side-deal-gone-bad for Enron. Being a professional is all about maintaining a state of mind, and a trader is never going to make consistent money until he or she achieves that frame of reference from which to operate. You may have heard some of these tenets before, and you'll most certainly hear them in one form or another again. But people tend to forget that trading to a great extent is a mind game, so this is useful repetition. Here are five nuggets of wisdom to help establish the right frame of mind for online futures trading.

1. Professional online futures traders focus on limiting risk and protecting capital. Amateur traders focus on how much money they can make on each trade. Professionals always take money away from amateurs.
2. Embracing your opinion leads to losses. When a online futures traders rationalizes a decline by saying things like, they are just shaking out weak hands here, or the market makers are just fishing for stops, then the day trader is embracing his own opinion instead of listening to the market. This is also called .being an amateur. and leads to a one-way revolving door called financial ruin.
3. Amateur traders turn into professional traders once they stop looking for the next great trading software and start controlling their risk on each trade.
4. In reality, day traders are not trading stocks, futures or options. They are trading other traders. Be aware of the psychology and emotions behind the person who is taking the opposite side of your day trade.
5. Professional day traders actively take small losses and they do so because they know their most important job is to protect their capital. After all, re-entry is only a commission away. Amateurs resort to hope to save their trades. In life, hope is a powerful and positive thing. In trading, hanging onto a trade based only on hope is very similar to a trader spending the rest of his life filling holes in rotten teeth when he has no skill as a dentist. In other words, it ain't pretty.

Now let's take a look at discovering which side of the market to day trade. Here's the key: Professional traders do not care about being on the short side or the long side of the market. All they care about being on the right side.

Finding the Best Market to Trade

Online futures trading the long or the short side is very easy once a day trader learns to ignore his or her own personal opinions. This means pushing aside any and all prejudices about the market and focusing on the current supply and demand situation. Markets rise on a day-to-day basis because current demand exceeds current supply. This has nothing to do with being in a secular bear market, a cyclical bull market, high P/E ratios or Maria Bartiromo's choice of a necklace. This has everything to do with what traders are willing to pay for a stock today. It doesn't matter if the demand is falsely created by a hedge fund taking the street. (buying large amounts of a single stock to drain a market maker of its inventory, forcing them to buy it back at a higher price). Or a squeeze that whacks shorts and forces them to cover, or a rumor that a biotech stock is being cornered by Martha Stewart. Demand is demand, and that is what drives markets higher. The inverse is equally true: If there is too much supply in the market, prices will fall. Although supply and demand can be more difficult to measure with a single stock, it is very easy to measure with a popular index such as the Dow for online futures trading. For online futures trading, this is why I feel strongly that one of the best contracts out there for both beginning and professional traders is the Chicago Board of Trade's mini Dow futures contract.(we call it the .dmini) The specific reasons are as follows:

Small Account Size

For stocks, the trader needs a $25,000 account to day trade. To day trade the mini Dow, the trader only needs to open a $5,000 online futures trading account. To buy (or sell) one contract, he typically needs $2,000 in his account (minimum amounts and margins can vary by broker, of course). Frankly, traders should be well-capitalized even if margins are low. They have to have enough to ride out the inevitable market ups and downs in online futures trading.

Bang for the Buck

For disciplined online futures traders who use live stops, the leverage in online futures trading mini Dow over stocks is a huge plus.

Better Spreads than the E-mini S&P

The mini Dow has the same specifications as the popular E-mini S&P contract:

• One point in the E-mini S&P = ten points in the mini Dow.
• One point in the E-mini S&P = $50; ten points in mini Dow = $50.

Liquidity

Although perfect for the smaller retail trader, the CBOT's The mini Dow will move an equivalent ten points in ten one point increments, giving the online futures trader six extra places to place a stop or target. mini Dow has caught fire and now has the liquidity to move size, chalking up online futures trading volume of more than 60,000 contracts daily as of this writing. In online futures trading, volume begets volume, so it's highly likely that volume will continue to expand as online futures traders, commodity trading advisors and managed funds take advantage of the trading advantages for this contract. It's a simple matter of getting the ball rolling. Figure 1 shows trading volume for the CBOT mini dow

Keeping on the Path of Least Resistance

A online futures trader can watch the 30 stocks in the mini Dow to get a very good idea of how the index is acting or is going to act. Getting a feel for all 500 stocks in the S&P 500 at a glance is as impossible as getting the Democrats to agree on a unified party message.

In an individual stock, all kinds of outside influences can move the price. Maybe insiders are dumping their own stock. Maybe an analyst has just issued an upgrade while his trading department is dumping shares off to an unsuspecting public. Maybe the company is giving positive forward guidance as its last hope to stave off bankruptcy proceedings. The factors affecting an individual stock are endless.

However, when investors in general want to sell stocks, the mini Dow reacts by heading south. If they want to buy, the mini Dow spurts green. The "Dow effect" encompasses individual investors, hedge funds, program traders and arbitrage traders. In addition, the mini Dow moves actively in all buy and sell programs.

The best way to online futures trading: mini dow, of course, is not by emotion, but by utilizing simple technical analysis tools to keep on the path of least resistance. The finely tuned art of technical analysis involves a process similar to a jury weighing the presented evidence during a trial and then deciding upon an outcome. By the same token, my final online futures trading decisions must be backed by evidence, not by emotion. The stronger the evidence, the greater the likelihood that a specific price action may occur. By contrast, the stronger the emotion, the stronger the likelihood that a trader is about to imprint the dead high or the dead low of the day. Based on this, I use a very simple trading system for online futures trading: mini dow.

My Online Futures Trading Scalping Account

A online futures trading scalping account is utilized to catch intraday moves and to go home flat at the end of each trading day. In my personal scalping account, my goal is to make one-half of one percent of my equity each trading day on a $100,000 account, that is $500 a day. This is net after commissions.

I also use daily dollar stops: I stop online futures trading for the day if I make four percent or if I lose two percent of my equity.

One of the setups I use is to initiate online futures trades off the 5-minute charts using a simple crossover moving average buy/sell and short/cover system. The setup is as follows: a 9-period and 18-period simple moving average (SMA), utilizing a bar chart that changes to green during an upside crossover, and changes to red during a downside crossover. Coloring the bars is a canned feature in many charting programs. If you are unfamiliar with this, the following will make it easier. In TradeStation, for example, go to .insert analysis technique and choose .paint bar.. From there choose .moving average crossover.. From inputs I add in the 9 and 18-period moving averages for fast/slow lengths, and type in green for Up Color and leave red as the Down Color.

Once I set this up, I noticed that many of the online futures trades occurred naturally as the markets head into a key support or resistance level. In this way, I am generally selling resistance and buying support, but only on confirmation from the crossovers. This is a .go with the flow trading process, and I take all signals with one exception: I avoid initiating new trades between 12:00 p.m. and 2:00 p.m. ET. This is called the .chop zone for a reason. In addition to being a simple system that avoids information overload, this method focuses on the current supply and demand situation, period. It keeps a trader on the path of least resistance. The most effective trading setups are simple in nature. Let's take a look.

Figure 2 is a weekly chart that displays a 10-month snapshot of the online futures trading: mini Dow.

Figure 2 is a weekly chart that displays a 10-month snapshot of the online futures trading: mini Dow.

Before the online futures trading day starts, I always like to glance at the larger time frames first. The key to consistent profits is to trade on the path of least resistance. The path of least resistance starts from the larger time frames and moves down through the ranks to the smallest time frames. Think of the weekly chart as a 1,000-pound weight on your chest. Then think of the 5-minute chart as a two-pound weight on your chest. Which is going to create more pressure on your body? It is ridiculous to try to move the two-pound dumbbell without taking into account the larger 1,000-pound weight bearing down on top of it.

During the week of May 2, 2003, the weekly chart experienced an upside moving average crossover and, as of early August 2003, had not looked back. I don't care how many books discuss the coming doom of the world economies. I don't care how overbought we are. I don't care how many traders are flaunting their superiority in that they would never go long stocks in this environment (Bearish geniuses in 2003 are almost as common as bullish geniuses in 1999).

What matters to me is this: Is the current big-picture perspective one based on too much supply or too much demand? This weekly chart makes it crystal clear that, as of this writing in early August 2003, current demand for Dow stocks continues to exceed the current supply. Sure, half of this demand is from frantic short covering, but that doesn't matter. Again, demand is demand. Period. By glancing at this chart, I know to spend most of my energy focusing on the long side. I will keep any shorts I initiate on a short leash. I will follow this procedure until this situation reverses itself. The heads-up here is that the weekly is getting close to pushing below its 9- period moving average. That is the first step in a market rolling over.

Figure 3 shows a daily chart of the mini-sized Dow going back to February 2003.

Figure 3 shows a daily chart of the online futures trading: mini Dow going back to February 2003. The daily chart is very important in determining the shorter-term current supply and demand situation. Think of the daily chart as the "heads up" and the weekly chart as the "confirmation." On the daily you can see we got an upside crossover about three weeks before it occurred on the weekly. The most powerful moves occur when the weekly confirms the action on the daily, and you have both time frames expanding in the same direction. A quick glance shows traders that the Dow is in a period of consolidation and, at the moment, demand is exceeding supply.

Figure 4 displays a 60-minute chart of the mini-sized Dow.

Figure 4 displays a 60-minute chart of the online futures trading: mini Dow. This is used to get a more accurate picture of the pressure that is going to affect the markets "today." The chart clearly shows the trader that pressure on the 60-minute chart is down, and that supply is exceeding demand. To utilize this information, a online futures trader can jot down the information in Table 1.

But how can this information be used heading into the online futures trading day? If we had demand across the board, I would focus more on long setups off the 5-minute chart, passing on most of the short setups. However, this picture represents a great intraday setup. With the weekly and daily pressure up and knowing that these charts represent huge amounts of buying pressure, I know not to expect a market meltdown and know that daily support levels should hold. With the 60-minute in a sell, I can expect that move to support to occur. On a day like this, I would take both long and short setups off the 5-minute chart.

Figure 5 represents the intraday trading chart utilizing the 5- minute time frame.

Figure 5 represents the intraday online futures trading chart utilizing the 5-minute time frame. In this chart, the first crossover occurs about 15 minutes after the open of regular trade, with the 9-period SMA (dotted line) crossing the 18. Supply is exceeding demand, so the market is heading lower. I short on the crossover, then double the number of contracts I want to trade on my execution platform. This is so that when the moving averages cross back up again, I execute a trade that covers my short and simultaneously goes long. By cutting out the noise, turning off the TV and focusing on the current supply and demand situation, the trader will be on the path of least resistance for the great majority of the time. Table 2 shows the execution result on this particular day.

This system is deceptively simply, and it will keep a online futures trader on the right side of the trend. Trades can be set up on all time frames, and there are, of course, ways to maximize this system utilizing a few other indicators. A very effective addition is the Keltner Channels with a 3.0 standard deviation. Keltner Channels are canned indicators that are available on most charting systems. They are similar to Bollinger Bands in that they will form what looks like a moving average trading channel on your chart. With this "channel" in place, a trader can get out of his position if prices hit one of the upper or lower bands of the channel instead of waiting for the next crossover to liquidate. If I get out of a position when it hits a Keltner Channel, I still wait for the next crossover to initiate my next position.

Traders are notorious for tweaking systems, and that is a good "tweak" for this system. However, it works fine without them. The biggest mistake I see people making with this crossover system is they use stops that are too tight, and they are too aggressive about trailing them. I place a 50-point stop in the DOW trades, and I don't trail it at all. Trailing a stop on this setup will almost always get you out at a bad price. Let the system do the work.

When Things Go Wrong

On Thursday, May 1, 2003, at 11:40 a.m. ET, a hardware failure at Chicago Mercantile Exchange precipitated a halt in E-mini S&P trading -- at the 905.00 level. They were still halted at the end of the day, even though the big S&P contracts rallied strongly to close at the 915.00 level. Globex did not reopen until 6:15 p.m. As a result, people were stuck short with E-mini S&Ps during this time, including me. What to do? Many newbies froze.

"I had no idea what to do," said Scott Sether, a private trader from St. Paul, Minn. "I've been trading E-mini S&Ps for about six months, and to be honest, I was like a deer caught in the headlights. My broker told me he would keep me posted on when they would reopen. All I know is I couldn't get out of my trade until the next morning. I was short ten contracts, and I lost $6,500."

Many traders were stuck short this day. When the CME finally reopened, traders who were stuck short ended up having to swallow some sizeable losses.

The key, of course, is for traders to know about their available choices if something like this occurs in the future. In this instance, Scott could have hedged by going long two of the big S&P contracts. However, it turned out that his broker is one of the many "e-brokers" out there that only trades electronic futures and does not trade any open outcry products. Scratch that idea. In addition, if a trader was short only a couple of E-mini S&Ps, it would not have been appropriate to hedge with the bigger S&P futures contract (one big contract = five minis). So what to do?

In this instance, Sether and others in the same situation could have gone long the mini-sized Dow, which is what I did. Once I was alerted to the trading halt, I immediately went long an equivalent number of mini-sized Dow contracts on the CBOT. Once completed, I was hedged through whenever trading would again resume, which turned out to be the next morning.

When it became evident that the market was going to "kill the shorts" who were stuck, I continued to pile on additional contracts to my mini-sized Dow trade. Not only did I completely hedge my losses in the E-mini S&P, I made nice profits on every long mini-sized Dow I owned over and above my hedge amount. By the time the CME opened later, the S&P had rallied more than 15 points. What turned out to be a disaster for the unprepared trader turned into a windfall for traders who were prepared for the worst-case scenario.

It is important to be aware of the different choices a trader has each day. Awareness brings empowerment and the ability to turn the inevitable glitch on an exchange into a powerful trading opportunity.

There is a ton of information out there, and many traders get easily confused on what to use and how to use it properly. By getting in a professional state of mind and by focusing on trading the mini-sized Dow, a trader has the best of both worlds -- an easy view of the current supply and demand situation and a clean instrument with which to trade that information. This simple system will keep the trader from second guessing himself, keep him on the path of least resistance and keep losses small while allowing winners a chance to run.