How to use the mini-dax to forecast S&P patterns

January 26, 2016 01:00 PM

Traders are constantly searching for an edge and one of best ways is to find correlated markets to trade off of. With the launch of the new Mini-DAX Futures (FDXM), which began trading on Eurex on Oct. 28, 2015, Eurex is offering a new twist on an old index. If you’re like most U.S. traders, you probably haven’t heard about it, so don’t feel bad. For many years, the DAX has been a viable liquid market in its own right and this new mini-contract enables U.S. retail traders to trade it in a smaller size. Learning about the DAX can give you an edge in forecasting U.S. market direction and confirming trends as you go through your decision-making process.

The Deutscher Aktien Index (or DAX) is Germany’s primary blue chip stock index. Most similar to the 
U.S. Dow Jones Index, the DAX consists of 30 of the largest companies traded on the Frankfurt Stock Exchange. The DAX has been somewhat obscured by the emergence of the Euro Stoxx 50 Index, but because Germany is the largest individual European economy, the DAX is still a very important index in Europe, which makes it highly influential on U.S. markets. 

In recent years, a large portion of the companies on the DAX have become increasingly more important to the global economy. These include: BMW, Adidas (ADS), Merck Pharmaceuticals (MRK), Volkswagen (VLKAY), BASF (BAS), Siemens (SIE), Bayer (BAYN), Daimler (DAI) and Deutsche Bank (DB). DAX futures are traded on Eurex, which is the largest European derivatives exchange. Because the European market is open for several hours prior to the U.S. market and the DAX plays such a key role in that market, the DAX can significantly influence what happens in the United States once the U.S. morning market opens. 

Sept. 11, 2001 was a tragic day that saw many lives lost and many markets were shut down. The NYSE and Nasdaq exchanges were in the heart of the damaged area and announced that they would not open for the day. At the time, Diversified Trading Institute (DTI) had a class full of students in Mobile, Ala. On the second day of a four-day class we had no live market to teach with. That night we tried trading the Nikkei futures and lost money; same thing with the Hang Seng futures. We contacted the Chicago Mercantile Exchange and asked them what was the most popular index future to trade outside of U.S. markets. A couple of people mentioned the DAX, so we had something to trade while our markets were shut down.

During the course of the next few months, we started learning how the DAX futures moved, what caused it to move and how it affected domestic U.S. markets. We learned the DAX was a dynamic and liquid market, especially for those who liked to get up early and had to go to work during the day. 

We started telling retail customers about the DAX and training our clients on how to trade it. For many of our students around the globe, understanding the DAX has had a very significant effect on their trading. Perhaps more importantly, we discovered that the Dax could help as an indicator for U.S. markets. A 2014 post in Seeking Alpha noted that “DAX has been the best European stock market index to predict the next day’s action of S&P500.”

Using the dax as an indicator 

After the U.S. stock market closes each day, the markets continue to trade around the world: First in Asia, then Europe and finally back to the United States the next morning. “The markets never sleep” (below) illustrates the concept of the 24-hour global market and emphasizes the region of the world that is in control of the market during four major time segments (all times U.S. Central). Notice that Europe is in control directly prior to the U.S. open.

This brings us back to the DAX. If Europe has primary influence on the markets directly prior to the 
U.S. open, why would you trade without knowing what the trend was during the European timeframe? What better way to gauge this trend than watching the primary index in Europe’s largest economy? More often than not, the S&P 500 futures will follow the DAX. “Setting the table” (below) is an example of how the S&Ps (right) often follow the DAX (left) during overnight hours prior to the U.S. open. Notice as the DAX opened it began to sell off and the S&P followed suit. The trend reversed after 3:30 a.m. and continued into the U.S. open. If the S&P doesn’t follow suit, then you should stay out or look for a reversal of the trend set in motion by Europe. By learning to use the DAX as a guide to the U.S. markets, you can improve your odds of a successful trade.

By taking the major European cash markets, including the DAX 30, and monitoring price movement you can calculate an average move for Europe as a whole. This average can then be used to predict a target for the S&P 500 based on the previous day’s close. Once you know where the S&P 500 should be, you can also calculate targets in other major indexes based on their correlation to the S&P 500.

Affordability & flexibility

Probably the biggest hindrance to the average person trading the DAX has been the large margin requirements. The DAX moves a tremendous amount in a day, let alone in a month. It currently moves about 240 points a day.  At €25 a point (and using 1.14 euro to U.S. conversion) that is $6,840 a day in movement. Compare that with the E-mini S&P 500, which moves about 33 points a day ($1,650 a day), and you can see why you would want to be interested in trading the DAX. But because of its volatility, the margins are much higher and therefore fewer people trade it. The average volume in the DAX is 122,000 contracts per day, compared to the E-mini S&P 500 that trades 1,800,000 contracts per day.  With less volume, markets can move more because it takes less buying or selling pressure to move the market. And as the volatility grows, so do margin requirements.

In order to solve this dilemma, Eurex has introduced the Mini-DAX. The Mini-DAX will trade in 1 point increments instead of 0.50 increments. It will be priced at €5.00 per point. At €5.00 per point, its daily price movement will be similar to the E-mini S&P 500.  Because of the reduced risk, margins will be much lower and volume potenitally much higher.

Because the Mini-DAX will be worth 1/5th of the large contract, people can trade three contracts and take on less risk than a full-sized contract. Traders can now trade multiple contracts as opposed to one. This allows traders to employ greater risk management procedures, like taking partial profit and maintaining a position with wider parameters. 

While the U.S. stock market is most liquid from 8:30 a.m. until 3:00 p.m. CT, many people do not have time to trade it during those normal trading hours. The Mini-DAX will be open from 1:00 a.m. until 3:00 p.m. CT, with the most liquid trading occurring in the hours before the U.S. open. So all of the night owls and early birds out there can do research on and trade the Mini-DAX  for several hours before the U.S. market opens. 

About the Author

Tom Busby has been a professional securities trader and broker since the late 1970’s. He is the founder of Diversified Trading Institute, which has been educating trades since my 1996.