Last updated on April 28th, 2020
If you think that you can take your day trading strategy and apply it to any old market, think again.
The importance of market selection is something that many people simply do not recognize.
It does not fall into the top three areas that people say you should focus on: psychology, risk, trading method.
At Netpicks however, picking the right instrument to trade is seen as a very important step to trading success.
Type Of Trading System
The vital first step to effective market selection is understanding the type of trading system that you’ll be employing.
If you want to trade a directional short-term trend-based strategy, a product that has a thick order book and spends much of its time not trending, is probably going to lead you down a path characterized by frustration.
On the other side of the coin, if you try to use a mean-reversion strategy on a market that tends to trend and be considerably more volatile, you might well find your capital vanishing into thin air.
Type Of Market Matters
It’s not only the level of movement that can have a large bearing on the success or failure of a particular trading system – it’s also the way it move and for what reasons.
A product like Crude Oil for example, might be more speculation driven (although for this product, the level of speculation in reality depends on who you are). It can ebb and flow without too much direction, but then quickly transition to a directional market.
There are also more fundamental markets that are heavily dependent on macro-economic and political policy.
For example, the US 10-Year T-Note is going to move (or not) based on the Federal Reserve and the FOMC policies. Volatility in this type of product tends to fluctuate when there is a change in central bank policy and during times of terror/geopolitical threats.
Finally you have index products.
These products can be directional, but because they are priced based on the valuation of several underlying products, their direction can be hampered at times.
Trading Intra-day Has Pitfalls
If you trade intraday, there are pros and cons for different market types. However, probably the most important thing to consider is the level of volatility and flow in the market.
Below is a comparison of two products.
Both are equity index futures, but in terms of how they trade, they are quite different. They are the Dax and the Euro Stoxx futures.
Volume and range play a big role in the differences along with the tick size (Dax = €25/point, Euro Stoxx = €10/point).
Thin Fast Moving Trading Products
One of the benefits of trading thinner, quicker moving products is that they flow much more easily towards their targets.
In the same vein, you usually find out whether you’re right or wrong relatively quickly.
Fast products also tend to provide many more opportunities per session than their slower moving equivalents.
A drawback to trading faster moving products is that stop order slippage can feature more prominently in your performance stats.
Another aspect to consider is that a setup or exit can occur very quickly and therefore it can in some circumstances, require a greater level of skill and focus to execute trades effectively. This leads to the fact that if you don’t take your stops in faster products, big losses can mount up very quickly indeed.
Additionally, when there’s an increase in overall market volatility, trading faster products can become more difficult.
Thick Slow Moving Products
There certainly are benefits to trading slower in preference to faster products. One of which is when you start out trading, you can trade with lower risk – your stops don’t need to be as big in order to find out whether a trade is going to work or not.
Because there is less risk per contract, a position size of equivalent risk will contain a greater number of contracts. This gives a trader much more flexibility in terms of trade management scheme by allowing for multiple scale outs.
Another great feature of this type of market is that they are for the most part more liquid and thicker in their order books. This means that a trader can dramatically increase the position size of a successful strategy before the market makes it difficult to achieve complete fills.
But there are always drawbacks and one is that it can at times be more difficult to get filled.
A well-placed limit order may see the market “tag” the price before moving away from your order without giving you a fill. In a faster market, price tends to slip through a limit order more easily and therefore a trader gets their fill.
A slower market also requires a great deal of patience at times.
When there’s little going on that needs to be priced into the market, there may be very few genuine opportunities in an entire session – for an impatient trader this creates a potentially dangerous situation.
When market volatility decreases for a period, this can become a major issue and tradability can be dramatically affected.
Market selection is something that time and time again I find people not taking the time to properly consider. Finding your Goldilocks market might just change your fortunes as a trader.