I could equally well call this article "Emini systems - the lack of logic behind emini trading systems" as, in fact, sometimes such lack illustrates better what the proper logic should be. And that's what this article will focus on, hoping that by exposing the lack of logic behind emini trading systems, we should be able to come up with the right logic, the logic needed to produce good, robust emini systems.
But, first things first. Let's start from what eminis are for as opposed to stocks, this is hardly a household term. While a large percentage of American households do maintain some position in stocks, the overwhelming majority of them have never dabbled in something as esoteric as eminis. Emini futures, to be more specific.
Emini futures are simply smaller-sized contracts of "full-grown" futures contracts that have been around for a few decades. Unlike the latter that have been traded on physical exchanges, eminis have always been traded electronically, allowing retail traders with access to the Internet to compete against institutional traders from the comfort of their homes or home based offices. That's what the "e" in their name stands for, namely "electronic."
The most popular such contracts include ES, YM, and ER2, that is the emini contracts of S&P 500 futures, the Dow futures and the Russell 2000 futures. In other words, these are eminis of stock index futures.
One of the best ways to approach trading eminis is through mechanical trading systems. A system like that consists of a set of objective rules that determine how to open a position in the emini futures market and then how to close it.
It is possible to make money trading eminis in a purely mechanical fashion. This author has designed several successful and relatively simple, robust emini systems so this opinion is grounded in his considerable experience.
However, not all trading systems are born equal.
This applies also to mechanical emini trading systems. One category of such systems consists of day trading systems. These are systems that open and close their positions the same day, thus allowing traders to use the intraday margin, which is much lower than the overnight margin. For this reason, emini day trading systems appeal particularly to retail traders, those market participants whose budgets (and so also trading accounts) tend to be smaller. Because of smaller intraday margins, those traders can trade with more contracts and thus can stand a better chance to make more money.
Since more and more traders enter the thrilling arena of day trading emini futures, more emini day trading systems are being made available to them by people who specialize in designing such systems, usually referred to as vendors. We could, in principle, also call them experts, although calling someone that way does not necessarily make him or her a true expert. Judging by the quality of what is available out there, the field of vendors is hardly crowded with experts.
One way to judge the quality of a trading system, whether it is an emini trading system or not, is by examining its logic. Systems with a poor logic, that upon a closer inspection can even be found self-contradictory, are usually poor performers or have parameters that are rather unappealing to serious traders who know their stuff.
A good example of a faulty logic is that of many simple (or rather simplistic) breakout systems that try to capitalize on catching a strong trend in the market. In other words, they attempt to identify periods of wide range expansion. From the logical point of view, the problem with such systems is that they usually take position on 50-60% of trading days, while such expansion periods, or strong trends, occur only about 30% of the time. There is a clear inconsistency in what the systems do compared to what they were really designed to do. As a result of this, many simple breakout systems overtrade, which reduces their performance. In the long run, this performance can become too poor to make such systems good enough for trading.
The reason why overtrading reduces the profits here is quite simple. On the days when the strong trend does not materialize, but the system is active, three trading outcomes are possible: a small profit, a small loss, and a big loss. The small profits are likely to be offset by small losses and what we are left with are only big losses. While these big losses may not be frequent, in some systems they can be as big as the big profits from strong trends that the systems like that try to catch, which is clearly bound to affect their performance.
The way to prevent the system from overtrading (and thus the degradation of its performance) is to ensure that it trades only (in practice, mainly) on the days the strong trends really occur. Can such a system be designed? The answer is: yes, it can be, but you cannot do this with simplistic ideas.
