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I. The CME Futures TRading Environment
Purpose of the Futures Markets
The future price of commodities such as gold, corn, beef, or Stock Index products such as the (S&P 500) are packaged into highly leveraged Instruments [Contracts] whereupon actual producers, end-users, and price speculators may buy or sell to each other in an Open Auction marketplace. This system of setting 'Future Guaranteed Delivery Price' was born of necessity and rapidly took hold in the Industrial Age as a method of significantly ensuring both stable product availability by aiding producers against oversupply price-dumping as well as industrial consumers against price-gouging shortage conditions.
In the United States, Chicago, Illinois hosts the premier auction facility of the Chicago Mercantile Exchange (CME), founded in 1898 as the humble Chicago Butter & Egg Board. From the days of post-mail, booming auctioneers, to teletype, tick, & telephone, the business of setting active price has grown exponentially with the advent of computerized online trading, allowing the biggest of institutional behemoths down to individual desktop traders easy, instant access to participate in the bid/ask auction process. Heads up though, this business of fair-value speculation is as fraught with risk to the unwary as it is highly lucrative to the well-prepared.
A variety of brand softwares exist for traders of all investment levels. Below we begin with participant introduction, followed by defining requirements & costs of a typical and popular example contract type (ES); then discuss the standard method of trading one's own capital, followed with illustrating the 'Funded Account' method. We define the differences in risk/reward management between the two.
Parties Involved, Trade Facilitation & Financial Obligation
Our focus here is zeroed in on what are known as "Retail" Traders, just like us... If you are trading specifically for personal investment purposes, or perhaps managing a small group or family fund with same purpose, you are considered a retail trader. Retail traders are in the $5K to ~ 30 Mil range, the overwhelming majority being the low end of that range. For the record, this is historically whom we've been associated with up to this point.
Institutions, or actual producers & industrial consumers, plus Banks, Investment Houses, Hedge Funds, etc. make up what are referred to as "Institutional" Traders. In recent preceding decades, with the ceaseless advance in information processing, automated trading has vastly overtaken the majority of transactional activity. Referred to as 'Algorithmic' trading, this type now governs roughly 80% plus of the overall auction process. What you will find here are key aspects of understanding primary tried & true considerations in building out algorithmic entry systems coupled with methodologies in trade management once in.
While its obvious Institutional traders bring in the big money plays, it is the Brokerage houses, i.e. the people whom you've given your money to handle your trade buy/sell obligations, who position themselves as the "Market Makers". Whether retail trader or institutional, it is these parties who take on the immediate fiduciary, essentially total, obligation on your behalf to finalize each and every trade performed as your auction representative. You compensate them with their fees & commissions and this is how they earn their keep. Not surprisingly, this is a highly lucrative business on their end.
As a natural consequence, these parties hold overwhelming financial power to move instrument price in one direction or another intentionally to fulfill client needs [especially the big ones] in order to fill standing, precise, price point orders, or "Limit Orders" as they are known, as they arrive or sit unfulfilled at a particular price point. You can see this price action quite regularly and especially through the use of "Volume Profile" analysis.
Throughout the day for example as price might be trending in one direction & then reverses a bit and continues on its initial trajectory, yes there might be short-term profit taking going on, but this is also a primary method brokers use in coming back to fill standing orders at those price points.
Brokers are also [by necessity] in the constant habit of acquiring "inventory" i.e. Contracts, from active positions in play, in order to maximize their ability to fill orders. Retail traders are quite often the 'victim' of these flush runs, [nanosecond lightning bolt price action] through the use of poor stop placement, unwittingly providing brokers with needed inventory as well as lining their brokers pockets via cash margin transfer, as it is most common in reality that your own broker was likely taking the other side of your trade from the get-go.
Now there is a saying in futures; "For every buyer there has to be a seller". The process of futures price management is a flat-out zero-sum game. If you made money on a trade, someone else had to lose it. Therefore all parties involved need to have a cash capital reserve to participate, without exception. Your broker may negotiate your trades, but they certainly don't guarantee your position without direct possession of specifically your capital cash on hand to cover losing trades. This capital is referred to as "Margin Capital". You can't trade without it. It is this necessity of Margin capital which will become the prima consideratio when deciding on direct (your money) vs. prop firm (their money at fee) trading. Now lets look at the aspects of margin.
When you or your automated strategy enters into a trade on the exchange, this is known as 'taking a position'. Upon entry in today's computerized exchange, the process is virtually instantaneous. Your software sends an entry order whether limit on price point or use of the 'Market' order. The difference is a limit order will not be filled unless price travels through it by at least one tick typically. A Market order means you just made an entry to buy or sell regardless of price-point, and almost certainly will take a small to not so small disadvantageous hit on where your position is filled.
Regardless of order type, when your broker processes the live order, instantaneously your account is evaluated for margin requirements and if acceptable your order is processed. Now using our example instrument of the E-Mini S & P 500 (ES), the open session margin requirements are dependent on the quantity of contracts you buy. In furtherance if the position is still held when the session you got in at is over, i.e. to be continued into the next trading day, your position will be further evaluated for increased margin requirement. So by definition, trading with intent to complete a trade overall in a single day is referred to as 'Intra-Day' Trading. Holding a position from one day to the next, i.e. passing through a daily session time expiration, is referred to as 'Inter-Day Trading.
Margin requirements [2024] in this example are at least $500.00 per ES contract for Intra-Day trades (DayTrading), and upwards of $12,500 per ES contract for Inter-Day trades (Overnight or Longer) positions. While margin requirements are at the discretion of brokerage houses, there also exists the additional condition of reserve capital requirements in most cases. This simply means that if you have in this example say $750.00 remaining in your account, and you take a single contract position, and the trade starts going south on you, your broker is likely to kick you out of the trade if your margin is closing in on 50%, or $250.00 in this case, in order to cover themselves and you against a large, sudden dis-favorable price move.
In trading futures, if you ever find yourself where your margin balance has gone negative, you have to replace that margin with more money, period. Zero exemptions. Given the advances in computerized trade management, Brokers these days pretty much will never let that happen in futures. On a side note, this game for beginners has to a large degree been risk-mitigated with the introduction in May 2019 of the E-Micro markets, which trade at 1/10th the entry cost of the E-Mini markets, with correspondingly reduced margin requirements as well.
The Differences in Sim vs. Real Trading Environments
So the first question everyone new to the arena asks "Well, where do I start?" And the answer is "Well, that's on you" :)...
Now of course you've been researching, endlessly watching videos etc., and if you've gotten to this page likely have already traded SIM, likely already have traded some live money, likely gave a good chunk of that away, and are now regrouping. Good call :), there's valuable information here...
There are key differences in each available methodology in trading futures. Yet all have essentially two choices in trade management: Market Orders or Limit Orders. As briefly mentioned above, and zeroing in now, a limit order is a precise price-point of entry or exit. Limit targets will always be filled precisely at your limit price point. Limit stops however are filled as close as possible to the desired price, but in practice are treated as a market stop-loss, meaning it's understood that if your trade has gone south on you and hits your stop, your broker gets you out no matter what and if no contracts were available at that price for whatever reason, they'll get you filled with any next available opposite trade. Now a market order is you hit the market buy/sell button and you get filled immediately but always at the broker's discretion of what's available. Whether getting in or getting out, you can count on taking a hit, and that hit is quite different in Simulated vs. Live trading. In the simulated environment things typically can go your way significantly more than Live.
Simulated trading is of course is just that; simulated... In Sim Trading, availability of optimal inventory relative to price position and your entry order is assumed at all times, meaning you will typically see precise results with your limit orders, and exceptionally close results to what you were expecting even when using market orders. Also, in the case of NinjaTrader for example, your sitting on $100,000.00 to start. So your flush with cash, your entries & exits are optimized, and if you were wrong and took a hit, no problem. Double or triple down on the next one. Or say for example if you've gone long 1 contract & the trade went 9 points against you & now its halted & trying to bounce back in your favor, you can "Dollar Cost Average" meaning hit that buy market button with 7 more contracts which pulls your breakeven practically down to current price if not right on it. You let it get a few ticks or a couple points in your favor & get out. You turned a loser into a winner. In Sim you can play that game all day long. Cool advice huh?? :) Oh hell no... Maybe in Sim but real-world live trading is very risky.
A point to make here is that in the absence of hard-nosed experience in evaluating the bigger picture, your initial 'play runs' using simulated accounts leave you with a false sense of security in that "EMOTIONALLY", you know its only SIM, so harm no foul no matter what happens. A very difficult if not impossible thing to do when using SIM is being able to treat it as though it's the real deal. Let me make it clear there is HUGE difference in trading fake vs. live money, in that the emotional component in trading live money is where you get eaten alive by your own 'Fear Factor'. This is why in that more than any other aspect of trading is concerned, maintaining discipline and training yourself to be patient is absolutely vital. Confidence and hard-won expertise are the key elements to achieve that mind-set.
So with that in mind let's compare a real environment vs. SIM. Let's start with costs. A cool thing about NinjaTrader is that the platform is freely available for download and you can use data essentially for free in several ways, whether playback using market replay or perhaps a free 10 minute old feed. When you're ready to do the real thing, you can lease the platform quarterly or better yet buy a lifetime license for essentially the cost of a year's worth of leasing. Data can be had in several ways also, with essentially two types. Basic, or first tier, or advanced, i.e. second tier with larger depth.
Avoiding details on that, suffice to say that for the great majority of traders, a basic data feed is just fine and frankly dirt cheap. For your live account $1500.00 U.S. is about the minimum I would recommend to anyone. That said, $2000 - 3,000.00. is a poshly safe number if starting out with the micros... Now you can certainly spend less though in starting your own live account. You can get in for as little as roughly $1000.00 total. Spelling that out, you can open an account with $500.00, lease the software for $225.00 / Quarter, & get a data feed for as little as roughly $9.00/month. If you took that route, you could trade the micros immediately. Now the nuances of trading E-Mini vs. E-Micro charts is discussed at length in Video 4 on our Youtube channel, as there are important differences you need be aware of... But in the moment for purposes of this article we are looking at cost, risk, & emotional considerations, so now lets have a look at what "Proprietary Firm", or funded trading opportunities have to offer.