How to Choose the Right Markets to Trade

In the trade room, members commonly ask about different products to trade and one of the key decisions a trader needs to make is to choose the right markets to trade.

How Many Markets?

There are many different products out there and finding the right product or handful of products isn’t always so straight forward. To begin with you need to ask the question of how many markets to trade. With your particular strategy, how many different markets can you keep tabs on at any one time?

If you’re unable to accurately execute your plan, then it could be that you’re trying to manage too many products at the same time. If you only trade a single market on the other hand, it may lead to you seeking trades that are not there and as a consequence, you end up taking sub-optimal trades.

Some traders will prefer to trade a single product and some will benefit from trading many. It’s a balance that needs to be struck and is dependent on the trader and their strategy.

There’s also the question of whether or not the markets that you choose to trade are always the same products (such as particular stocks or FX pairs) or whether you can regularly swap out markets in order to trade where the action is.

The upside of having the flexibility is that you can select markets that you believe will provide you with the highest number and quality of setups for your trading strategy.

The downside is that constantly trading different products prevents you from getting to know any of them intimately well.

Market Correlation

If you’re trading multiple markets, there is another point to consider. How correlated are the products that you’ve selected to trade?

If you choose to trade the Dax and the Euro Stoxx futures for example, the chances are that you will frequently find them moving together. This has implications on the level of risk you face if conditions aren’t ideal, but also gives rise to another potential stumbling block.

If the markets you trade are similar and tend to move in sync with one another, the chances are that you’ll get setups occurring very close to one another or even simultaneously – if you’re executing manually, this could be a problem.

Considering the level of correlation between the products you have selected is a very important factor.

Liquidity and Risk

The way a market moves is vitally important too. How much is it worth per tick? What’s the normal range for a day? What’s the normal volume traded per day? How liquid is the orderbook? All of these factors make up what your execution and trade risk will be.

Execution risk is about whether it will be easy to get in and out of a market at the price you want and for the number of contracts you want, without too much trouble or slippage. Trade risk is what you will need to risk in order to find out whether or not a trade will work.

A market like the Dax for example, is very thin on the order-book but is pretty liquid. Slippage may well be an issue, but you shouldn’t have too much trouble getting filled if you are flexible. It also generally moves about a great deal and therefore the trade risk is likely to be much higher on this when compared to other markets.

Taking things to the other end of the spectrum, the Schatz tends not to move very much during a session (perhaps around about 12 ticks for the entire Eurex session) and has many thousands of contracts queuing in the orderbook at any one time.

Global Focus

Having a good awareness of what’s going on globally can be hugely beneficial too. The QE dependence many markets have is a sign of just how important central bank’s policies have been particularly since the financial crisis. The recent plummeting value of a barrel of oil has afforded perhaps more opportunities in the energy markets. Different regions of the world come in and out of market focus.

Recognizing which markets are therefore likely to be in focus over a certain period can help you to select products that are likely to be leading rather those that are likely to be following.

How to Choose the Right Products to Trade

Selecting the right products to trade comes down to a variety of factors including those reliant on analysis of your own strategies and what the markets are doing themselves. You can’t expect to be able to cherry pick the best products to trade all the time, but what you can do is take account of your own trading strategy, risk tolerance, market correlations and key market focal points in order to better choose the right markets for you.