Stock-Market-Observations

• Short Term – Since June 15, 2011
  
• Up Trend Underway & The Channel Is Defined
• Buy Completed, Short Term Speculator Purchase

• See the sidebar for “Odds ‘N Ends” under the category Huh???  You will find ideas, glossary and explanations.  For methodology, see the category Indicators.

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Friday is the release of the employment report.  I have seen the market crest or bottom during the second hour of trading after the release of this data.  The following chart shows the trend lines in force.

07-07-11, XLY 20 MIN BARS, SINCE 06-14-11, TREND LINES

How about the question of what should one buy at a market bottom???

First, I believe that “A rising tide lifts all boats” and that means if you buy at the right time and the stock market goes up, you should make money.  How correctly you chose a stock will decide how much profit you will make.  Naturally it’s still possible to lose money buying a terrible stock when the timing is correct but it’s less likely.

Click on the following link to see a few stocks in an uptrend over the past several years.

http://stockcharts.com/def/servlet/Favorites.CServlet?obj=ID4485509&cmd=show[s235110147]&disp=O

My preference for many years has been to diversify and buy the S&P 500 index.  The ETF stock that reflects this index is SPY.  SPY is a good choice for a short time frame like a couple of weeks, but as the time frame lengthens there are problems with most ETFs reflecting the underlying index.  For longer time frames I would chose a mutual fund that is indexed to the S&P 500.  But neither of these are my trading vehicle of choice.

So what do I buy???  I buy and sell the S&P 500 futures on the CME Globex exchange.  They are called “E-Mini S&P 500 futures” and the contract is represented by a 5 character symbol [“ES” plus month (1 character) plus year (2 characters)].  These futures contracts trade almost 24 hours per day and the brokerage cost for a round trip is about $10.  During normal trading hours the contracts have extremely good liquidity and a market order is easily executed.  After hours trading the liquidity is still present but you must use a limit order to purchase or sell (see glossary).  The S&P 500 futures contracts expire at 3 month intervals.  This simply means you are forced to sell your contract on the expiration date.

The September 2011 contract, which is trading currently is represented by ESU11 (ES+U+11).  These futures contract have very high leverage.  One contract has an initial margin “cost” of $5,000 (brokers require more than the initial margin (cash) to open a commodity futures trading account).  One point in the SP 500 represents a $50 gain or loss per contract.  For instance a good day where the DJ Industrials rises 100 points would be approximately 10 points in the SP 500 index.  The contract would also rise 10 points.  This would be a $500 profit per contract ($50 X 10 = $500).  This represents a 10% profit for one day ($5,000 cost, $500 profit).  Obviously the reverse is also true.  A decline of 10 points would be a loss of $500 per contract.

Because these futures contracts trade 24 hours per day, a STOP is suitable for (1) protecting an initial position from going bad and (2) protecting your profit later in the transaction.  See STOP in “Odds ‘N Ends” under the category, HUH ???

For an overall look at what can happen, lets view the current rally that began in earnest on June 27th.  If someone had bought one contract at the close of normal trading on 6/27/11 and held it to the present, 7/7/11, the profit for one contract would be approximately 75 points or $3,750.  This represents a profit per contract of 75% ($5,000 cost, $3,750 profit).

In futures contract trading your account is “market to the market” at the close each day.  That means if you made a profit today, that profit is credited to your account.  But if you lost money today, that loss is debited to your account.  Your initial margin “cost” is $5,000 but if your contract equity falls below $4,000 per contract, you have a margin call.  A margin call is additional money that you must deposit into your account before the next day’s opening, or your account will be liquidated to satisfy the margin call.

In the distant past I thought trading futures contracts was terrific and flawless as (1) they provided great leverage, and (2) they had the ability to make you rich fast.  How incredibly naive.  In the 1980s I learned the very bitter lesson that leverage cuts both ways. It’s a lesson once learned, never forgotten.

For instance, if one used all their available money to purchase futures contracts with the expectation that the market was going to rise, a major obstacle could possibly lay in your path.  You could be correct on the direction of the market over the next month but first it might make a detour for a few days that wipes you out.  That’s being right and wrong in the same transaction.  But the only thing that mattered was that you were wrong before being right.  In this instance you lost all of your money in the first few days of the detour and there was no second chance at being right over the next month.  This is the very foul edge of leverage with futures contracts.  The moral of this story is (1) buy only enough contracts that would allow you to comfortably meet the margin call, (2) don’t meet a margin call, (3) sell and re-buy if you are incorrect on your timing, and (4) don’t treat futures contracts like stocks.

Futures contracts are not long term investments like stocks.  They are trading vehicles and one doesn’t hold them through thick and thin.

Are taxes eating you alive and you need to invest for long term status???  Relax, if you pay lots of taxes you’re doing something right.  But there is a solution when trading and never achieving long term status.

Since 1981 everyone that trades futures contracts enjoys favorable tax treatment (form 6781, “Gains and Losses From Section 1256 Contracts and Straddles”, see pdf file below) . Commodities futures contracts are taxed on a 60/40 basis, where 60 percent of the gains are taxed as long-term gains and 40 percent of the gains are taxed as short-term gains.  This is regardless of the holding period be it 1 day, or 1 year.

IRS Form 6781

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This entry was posted on July 7, 2011 at 7:19 PM and is filed under UPDATE. You can subscribe via RSS 2.0 feed to this post's comments. You can comment below, or link to this permanent URL from your own site.