Lessons from the Pros


Using Futures to Trade ETF’s

Over the last fifteens year or so, the financial product known as the Exchange Traded Fund has grown immensely in popularity, and for good reason.  ETF’s, as they are commonly referred to on Wall Street are closed end funds, meaning that they are pools of money that are put together with a specific mandate. In the example of the SPY, the most popular and liquid ETF, the objective of the fund is to match the returns of the cash S&P 500 by continuously managing a portfolio to match the index.    These funds are closed ended because after the initial investors pooled their money,  these funds no longer accept new money. This allows them to trade exactly like a stock, with the major difference being that an ETF is designed to track a broad based equity index or commodity.  Although there are literally thousands of ETF’s to choose from, the two most popular ETF’s (and thus most liquid) of the index funds are the SPY, which track the S&P 500, and the QQQ whose mandate is to mimic the Nasdaq 100,  an index comprised of the biggest stocks in the Nasdaq.

ETF’s are a great alternative to stocks in accounts where Futures contracts are not permitted to be traded, or where leverage is not appropriate. Because ETF’s track a broad index, they tend to mitigate the gap risk associated with stocks.  Even when this may be the case, the futures markets are a very good odds enhancer in trading the ETF’s because the futures often tend to lead, and  they trade continuously throughout the night.

On Wednesday of last week, I was conducting a stock XLT in which we not only find stocks to trade intraday, but we also track, and trade the SPY and QQQ. We start the session with what we call the prep screen in which we detail the supply and demand levels for the aforementioned ETF’s in order to track these indexes. It’s important to watch these indexes when trading stocks as they exert the biggest influence on their price.  Below is the screen capture of that day’s Prep screen. Notice I’ve highlighted the supply levels of both the SPY and QQQ because they came into play later that day as the Federal Reserve announced that they were going to end the quantitative easing program in October.

XLT 9-17-2014

As we can see in the charts, in both examples,  the QQQ hit the level of 100.00 spot on, before turning down intraday, and the SPY actually pierced the higher line of supply. Why did that happen?

QQQ prep screen supply 09-17-2014

SPY Supply 09-17-2014

If we look at the corresponding Futures contracts we can see that the NQ ( Emini Nasdaq) hit its supply level at the same time the QQQ was filling its gap.
This made for a high probability trade in both instruments.

NQ 09-17 supply

The ES ( Emini S&P 500) on the other hand did not have a quality supply level as it made an nominal all-time high.  This produced a higher high on the SPY which made that level invalid.

ES 09-17 supply

So as we can see, using the futures markets to time our entries in ETF’s can be very useful.  And since there are EFT’s for pretty much every commodities market, futures, if used in conjunction with supply and demand can produce high quality entry points.

You can find out more about the stock futures market, and how to trade, starting with a free Power Trading Workshop at Online Trading Academy. Classes are held on a regular basis at our local financial education centers and online. Complimentary registration for an upcoming class is available here.

So until next time, I hope everyone has a great week.

DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.

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