Why Trade Dow Futures?

The Dow is by far the worlds most followed stock index, and is the reference point for millions of traders and investors around the globe. The Dow is a price-weighted index of 30 blue chip companies in the US representing nine economic sectors of the economy. The leadership position of the component Dow stocks results in an extremely high correlation of the DJIA to broader U.S. indexes, such as the S&P500®. CBOT (Chicago Board of Trade) Dow, Big Dow, and mini-sized Dow futures, therefore, provide opportunities for traders and individual investors to gain market exposure and manage risk between correlated equity index futures, underlying stocks, stock baskets, and single stock futures.

CBOT Dow futures are traded virtually around the clock. You will have access to the futures markets even when the underlying stock market is not open, as is the case with the release of many significant economic statistics such as unemployment, jobless claims, GDP, CPI, and PPI just to name a few (which are released at 8:30 a.m Eastern US time). This can be an opportunity for traders and investors who wish to quickly take advantage of market reactions to such events before the stock market opens, and to earnings releases after the market closes.

Electronic access, highly liquid markets, low margin requirements, and beneficial tax treatment have combined to establish CBOT Dow futures products as outstanding trading and hedging instruments for equities and futures traders alike.

Use of Leverage

Leverage is the primary reason small speculators and traders use Dow futures instead of trading an ETF that tracks the same index. Exchange traded funds (ETFs) require margins of 50% of the underlying contract. Leverage can result in large profits as well as large losses. For example, the E-Mini Dow future contract changes $5 in value for every point the DJIA moves and also has a margin requirement of $6,875 per contract (as of 3/09). Let's say you had $6,875 to invest and the DJIA was at 8000. If you invested in an ETF like the DIAMONDS (DIA) the DJIA would have to move to 16,000 before you experienced a 100% return, however, with the E-Mini Dow futures, the DJIA would only have to move to 9,375 for you to experience the same 100% return. The power of leverage is that only a 17.2% move in the underlying index produces a 100% return for the investor.

Types of Dow Futures

Due to the popularity of Dow futures trading, the CBOT lists several types of contracts of varying sizes. They are the E-Mini Dow, the Dow, and the Big Dow futures. The contracts differ with respect to size and margin requirements with Dow futures contracts being 2 times the size of the E-Mini Dow, and Big Dow futures contracts being 5 times the size of the E-Mini Dow. Because of their smaller size, E-Mini Dow futures are primarily used by small speculators and traders whereas Dow and Big-Dow futures are primarily used by larger financial institutions, CTA's, and hedge funds. The following table summarizes the specifications of each type of Dow futures contract.

	E-Mini Dow	Dow	Big Dow
Ticker Symbols	YM	Electronic: ZD Open Auction: DJ	DD
Contract Size	$5 x the E-mini Dow futures price	$10 x Dow futures price	$25 x the BIG Dow futures price
Tick Size	1 index point = $5 per contract	1 index point = $10 per contract	1 index point = $25 per contract
Settlement/Expiration	Cash settlement to the Special Opening Quotation of the Index on Final Settlement Day, which is generally the third Friday of the contract month.
Trading Hours	CME Globex: Monday - Thursday: 5:00 p.m. to 3.15 p.m. and 3:30 p.m. to 4:30 p.m. Central Time (CT) next day, shut down period 4:30 p.m. to 5:00 p.m. CT; Sunday and Holidays: 5:00 p.m. to 3:15 CT next day.	CME Globex: Monday - Thursday: 5:00 p.m. to 3.15 p.m. and 3:30 p.m. to 4:30 p.m. Central Time (CT) next day, shut down period 4:30 p.m. to 5:00 p.m. CT; Sunday and Holidays: 5:00 p.m. to 3:15 CT next day. Open Outcry:8:30 a.m. to 3:15 p.m. CT	CME Globex: Monday - Thursday: 5:00 p.m. to 3.15 p.m. and 3:30 p.m. to 4:30 p.m. Central Time (CT) next day, shut down period 4:30 p.m. to 5:00 p.m. CT; Sunday and Holidays: 5:00 p.m. to 3:15 CT next day.
Contract Months	March, June, September, December.
Margin Requirements (3/2009)	$6,875 per contract	$13,750 per contract	$34,375 per contract

Dow Futures Contract Months Explained

Dow futures contracts are cash settled and will have no delivery of any security at expiration. Dow futures contracts roll over quarterly and will expire on the third Friday in March, June, September, and December. The contract with an expiration date closest to the current date is considered the front month and this futures contract will have the bulk of the trading volume; however, contracts with different expirations may be traded at the same time. The table below shows the exchange codes for various futures contract months. For example, the E-Mini Dow futures contract expiring in June 2009 would have the ticker: YMM9.

Month	Symbol	Month	Symbol	Month	Symbol	Month	Symbol
January	F	April	J	July	N	October	V
February	G	May	K	August	Q	November	X
March	H	June	M	September	U	December	Z

Opening an Account with a Futures Broker

In order to trade Dow futures, you need to have an account with an online broker that supports futures trading. Since futures trading has only recently become accessible to individual investors, there is a varying level of capabilities offered by different online brokerage platforms. We briefly discuss our top 3 here.

Interactive Brokers

Interactive Brokers is probably the biggest online futures broker, providing access to 80 markets worldwide from one account. With Interactive Brokers, you have access to the majority of markets that major financial institutions do. If there is any complaint about Interactive Brokers, it is the least user friendly of the 3 I mention here.

Thinkorswim

Thinkorswim is the highest rated online broker in 2009 by Barrons, and has won the award 3 out of the last 4 years. Thinkorswim has a great trading platform and offers trading support from multiple devices (making good use of the new IPhone). Its commissions are a bit higher when compared with Interactive Brokers, but it more than makes up for it with good trading technology and good trading research. You can read the Barrons article here.

TradeStation

TradeStation is another highly rated broker by Barrons. TradeStation is used by many investors and traders because it is the "leader in rule-based trading". With TradeStation, you can write computer programs that will make trades for you. TradeStation provides functions that perform technical analysis and you can backtest your strategies on their database. This truly is a powerful tool.

Trading Dow Futures Using Technical Analysis

If you are going to be actively trading Dow futures, it will be important for you to understand the basics of technical analysis, which is used by the majority of futures traders.

Trends,Trendlines, and Moving Averages

There is an old adage among futures traders that states "the trend is your friend", which indicates how important it is to follow trends in order to make money in the futures markets. Trend lines are an important tool in technical analysis for both trend identification and confirmation. A trend line is a straight line that connects two or more price points and then extends into the future to act as a line of support or resistance. The charts below show up and down trend lines. Notice how the trend lines can be drawn by connecting points 1 and 2 and how the prices test the trend line level again in the future at points 3 and 4. In the case of an uptrend, the trend line provides support, and in the case of a downtrend, the trend line provides resistance.

Traders also use moving averages to determine when a new trend is forming or when a trend has reversed. The chart below shows two moving averages: the 50-day SMA (Simple Moving Average) and the 200-day SMA. The 50-day SMA represents the average price over the previous 50 trading days, the 200-day SMA represents the same, except it is calculated over the last 200 days. To detect a trend reversal, traders look for when the security price crosses through the moving averages. In the graph below, the uptrend is reversed when the stock price crosses through both the 50-day and 200-day moving averages. Also notice earlier that the stock price falls through the 50-day moving average, but bounces off the 200-day moving average which is acting as support.

Support and Resistance

Support and Resistance are key levels where the forces of supply and demand are equal. At support levels, equal supply and demand prevents prices from falling any further. At resistance levels, equal supply and demand prevents prices from moving higher. The normal imbalance between supply and demand is what forces prices higher (more demand) or lower (more supply).

In the chart below you can see how the red line acts as resistance, as the price bounces several times off the level and each time heads lower. On the other hand, the green line acts as support and prevents prices from falling any further. Sometimes support and resistance levels do not hold. Notice how the red line acts as support for prices in August and September, and then prices break through the support level. Prices headed lower because supply overwhelmed demand on the 3rd test and didn't establish a new support level until much lower (the green line). A lot of times old support levels become new resistance levels as is the case with the red line. This is fairly common because a lot of people "miss the boat" the first time around and are waiting to sell if the price reaches the old level again.

Furthermore, round numbers may act as support and resistance levels due to the psychology of individuals. For example, people like to say "I'll buy the Dow if it gets to 7,000" or "I'll sell the Dow if it gets to 10,000". The numbers represent psychological barriers for the market. On options expiration days (the 3rd Friday of every month), prices tend to converge toward round numbers also because they represent options strikes.

Fibonacci Retracements

Fibonacci retracement is a very popular tool among technical traders and is based on the key numbers identified by mathematician Leonardo Fibonacci in the thirteenth century. However, Fibonacci's sequence of numbers is not as important as the mathematical relationships, expressed as ratios, between the numbers in the series. A Fibonacci retracement is created by taking two extreme points (usually a major peak and trough) on a stock chart and dividing the vertical distance by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8% and 100%. Once these levels are identified, horizontal lines are drawn and used to identify possible support and resistance levels. The following video provides a good synopsis on how to use Fibonacci retracement levels in your trading.

Arbitrage Trading Strategies

Arbitrage, in its purest form, is defined as the purchase of securities on one market for immediate resale on another market in order to profit from a price discrepancy. When trading Dow futures, one can execute an arbitrage strategy by also trading the futures against the underlying stocks or an ETF that tracks the Dow. When the relationship between the two deviates too much, one can create profit by going long one and short the other. In practice, for a small investor, arbitrage opportunities will be hard to find and are only profitable for the largest financial institutions.

A more practical strategy similar to arbitrage is to trade the spread between two related markets. There are many traders who actively trade the spread between Dow futures and S&P futures, commonly known as the SPUD spread (the acronym stands for S&P under Dow). The correlation between the two futures prices is usually around 95%, so you can exploit this relationship by going long one and short the other if the prices get too far out of whack. You can also trade Dow futures against Nasdaq futures, but this correlation isn't as high.

Options on Dow Futures

For more complicated trading strategies, options on Dow futures are available. With Dow futures options you can enjoy the same generous margin requirements and round-the-clock trading. A lot of traders use Dow futures options to hedge their underlying positions in Dow futures. For example, one might short sell Dow futures options and hedge their position by purchasing the equivalent amount of Dow futures.

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