The Benefit of Diversification with Micros
Micro futures contracts allow traders to diversify their positions across multiple indices without committing a large amount of capital. A trader with a $10,000 account could previously only afford to trade one or two E-mini contracts. With micros, the same trader can now take positions in all four major US indices: the S&P 500 (MES), Nasdaq-100 (MNQ), Dow Jones (MYM), and Russell 2000 (M2K). This diversification can help to smooth out returns and reduce portfolio volatility.
For example, on a day when technology stocks are selling off (hurting the Nasdaq-100), industrial stocks might be rallying (helping the Dow Jones). A trader holding both MNQ and MYM positions would see the loss in one position partially offset by the gain in the other. This is more difficult to achieve with standard E-mini contracts due to their high margin requirements. A trader would need at least $50,000 in their account to hold positions in all four standard E-mini contracts simultaneously.
Scaling In and Out of Positions
Micro contracts provide the flexibility to scale in and out of positions with greater precision. A trader who is building a long position in the S&P 500 can start by buying one or two MES contracts. As the trade moves in their favor and their conviction grows, they can add to the position by buying more MES contracts. This is known as scaling in. This technique allows a trader to test the waters with a small position before committing fully.
Similarly, a trader can scale out of a winning position. Instead of closing the entire position at once, they can sell a portion of their micro contracts at different profit targets. For example, a trader holding 10 MES contracts could sell 3 contracts at the first target, 3 at the second, and let the remaining 4 run. This allows the trader to lock in some profits while still participating in any further upside. This level of granular control is not possible with standard E-mini contracts.
Worked Trade Example: Scaling In
A trader believes the Nasdaq-100 is bottoming and wants to establish a long position. The MNQ is trading at 14,500. The trader buys 2 MNQ contracts at 14,505. The initial stop loss is at 14,480. The risk is 25 points, or $25 per contract, for a total risk of $50. The index rallies to 14,550. The trader adds 3 more MNQ contracts at 14,555. The stop loss for the entire position is moved up to 14,520. The total position is now 5 MNQ contracts. The average entry price is 14,535.
The index continues to rally. The trader’s profit target of 14,650 is hit. The total profit is 115 points on the first 2 contracts and 95 points on the next 3 contracts. This is a total of (115 * 2 * $0.50) + (95 * 3 * $0.50) = $115 + $142.50 = $257.50. By scaling in, the trader was able to build a larger position as the trade confirmed its direction, leading to a larger overall profit.
The Downsides of Over-Trading
The low margin requirements of micro contracts can be a double-edged sword. For disciplined traders, it is a benefit. For undisciplined traders, it can lead to over-trading. The temptation to take on too many positions or trade too frequently is high when the cost of entry is low. A trader with a small account might be tempted to load up on 10 or 20 micro contracts, effectively taking on the same risk as trading one or two standard E-mini contracts, but without the same level of capital to back it up.
This can lead to rapid account depletion. A few losing trades can wipe out a significant portion of a small account. It is crucial for traders using micro contracts to maintain strict risk management rules. A trader should never risk more than 1-2% of their account on a single trade, regardless of how small the margin requirement is. The accessibility of micro contracts should not be an excuse for reckless trading.
Key Takeaways
- Micro contracts enable diversification across multiple indices for smaller accounts.
- They offer the flexibility to scale in and out of positions with precision.
- The low margin requirements can lead to over-trading if not managed carefully.
- Strict risk management is essential when trading micro contracts.
- The benefits of micros are best realized by disciplined traders.
