When traders become involved with futures and forex, there is often a draw to a wide range of markets. For instance, many traders go into futures looking to trade equity index derivatives like the e-mini S&P 500; however, sometimes after a slow start, or because of account size, they drift into other markets trying to find an edge. Likewise, currency traders who start trading a major pair may eventually begin to look at other pairs, wondering what other exchanges may have to offer them. Today, we will examine one of the most necessary criteria for determining which markets might be right or wrong for you.
One of the first things to consider when choosing a tradable market is the size of your account against the potential markets to trade. Too often, traders will go after a popular market. However, just because a market has the highest volume and is well written about doesn’t mean that it’s for you.
Account size matters
Let’s take a real example of a trader I knew who began to trade the Emini S&P 500 contracts with an account size of $2,500. Each handle (four ticks) of movement was valued at $50 on a single contract, which amounted to 2% of this account’s actual value. Therefore, the trader’s education was interrupted, and his learning process came to an end because he did not have an appropriate account balance for the market he was trading.
Consider that well-attested models suggest risking 1 or 2% on a single trade. For this man, that meant he could only take $50 of risk for each trade, or four ticks. Anyone who follows the index futures knows that four ticks often move in a single flash. Hence, on multiple occasions, as this man was entering a trade looking for confirmation on his entry fills, he was simultaneously stopped out. Furthermore, this type of risk parameter limited him to only scalping the markets. While scalping might be rewarding for some, it is not for everyone. The closest four ticks on any market are usually more random price action.
Secondly, once this man realized that scalping while risking a handle was not going to be his ticket to success, he began to take on further risk. Rather than trading for a $50 stop, he increased his trade risk to $150 of risk, or three handles, which amounted to 6% of his account's worth. After three losing trades in a row, which inevitably came, he was down nearly 20% of his account value.
You don’t need to trade the biggest market
To make matters worse, his problems were compounded because he could only trade a single contract, so he was never able to learn how to maximize profits by scaling out and allowing a winning position to run.
Perhaps his biggest mistake was insisting that he had to trade what he considered to be the sexiest benchmark of futures trading, the S&P 500. Fortunately, the S&P 500 futures now have a micro contract, which fits much better with a small account. However, for this trader, the damage was already done.
What this trader might have done as an alternative would have been to determine which market(s) are suitable for his account size. Chances are, if it’s a futures market and you don’t have enough of a balance to hold a position overnight, but depend on day trading margin that your account is underfunded for this market.
Alternatively, if very small moves in the market you are trading are causing you to get stopped out very shortly after entry because your risk parameters are too tight, then it is likely that a different market may benefit you.
The good news is that now that micro futures contracts are available, there are opportunities for traders with smaller accounts. Furthermore, with Forex markets, trades can be divided into very small increments, permitting even very modest accounts with viable options.
Another example comes from a trader who became deeply interested in U.S. Treasury futures, particularly the 30-year bond and 10-year notes. This trader wanted to hold positions for an hour or longer while trading multiple contracts. Unfortunately, this was hard to manage in an account of around $7,500. However, this trader had learned many of the fundamentals and patterns of these markets. When she was advised to try her same strategies on the 5-year note, which trades in a more modest fashion, this trader found the key to success. She was able to use much of the knowledge she had gained from the larger Treasury futures on a contract that was much more suitable to her needs. These factors are not the sole criteria for determining your market, but are important variables in the process of becoming a successful trader with an identifiable market.
Fundamentals
Many traders start out by learning a technical approach to the markets, and rightfully so. There is an abundance of educational resources available to learn technical skills, and the style doesn’t require an extensive background in economics. Another benefit of technicals is that the methodology applies the same to all markets, creating a genuine appeal.
However, it’s also imperative to have at least a minimal understanding of market fundamentals, the economic basis that, at least in theory, creates supply and demand in a given instrument. While an understanding of fundamentals is no instant or automatic ticket to success, a familiarity with these underlying variables may assist you in entering profitable trades or avoiding potentially unprofitable positions.
One negative example comes from a trader who had come to me for help after losing money in his first two years of trading. In the course of the conversation, I learned that he never paid attention to news of any sort, nor did he glance at a calendar showing economic releases, and even though he also traded stocks, he never looked at an earnings calendar.
After looking over many of his trades from the prior quarter, we were quickly able to ascertain multiple instances of where money would have been saved if he had merely avoided positions on instruments that were correlated to news events. In fact, as it turned out, he was not as bad a trader as he thought, and would have been near break-even in his most recent quarter if he removed trades that headlines should have told him to avoid.
It’s not the same for every market
For currency traders who are unable to commit a large portion of time toward homework, it may be best to concentrate on markets that have the most accessible information. In that case, you could likely give attention to the major markets where data is more available. Furthermore, one could delimit trading to their native currency. For instance, if you live in the United States, it may be more challenging to keep aware of conditions in Australia; however, it ought not to be very cumbersome to maintain a databank of economic circumstances in the U.S.
Even so, if you are trading the U.S. dollar (USD), it must be paired against another currency; thus, you would need to be conscious of what to expect from that market based on its calendar and other factors.
There was an occasion when I was trading the USD, and my thesis was correct on how the dollar would behave; it rallied against 6 of the 7 most widely traded currencies. However, I happened to take my bullish USD position against the one currency that had a fundamental reason to be stronger than the dollar. This is something I failed to consider when I entered the trade, nor was this something my charts were able to show me, but looking at an economic calendar, combined with some good commentary, would have made me aware of this and would have been the difference in losing and winning a trade.
Likewise, if you are trading futures markets, then you must be conscious that these are highly correlated to fundamentals. Metals like gold and copper are seen as barometers of risk and economic health. Fuels like crude oil gauge the supply/demand situation of the economy. Meanwhile, fixed income products such as U.S. Treasury bonds and notes are highly correlated to the U.S. dollar, and many times the Japanese yen, and even at times the U.S. stock indexes.
Understand the correlations
Another interesting story comes from a trader who decided that agricultural futures were his market. This trader was confident in understanding broader economics, yet failed to take into consideration the particular economics for the specific markets he was trading. Soybean futures can be affected by China’s economy, which imports beans from the U.S. Wheat futures can be affected by labor issues in Argentina, a primary exporter of the product. Corn futures can be affected by rainfall and temperatures in the Midwest of the United States. Furthermore, cattle and hog futures can be affected by the price of corn, which is used as a feed.
These are just a few examples that demonstrate the complexity of the fundamentals that lay beneath every market. While it is unlikely that most traders will perfect a fundamental analysis of every market, traders have access to enough information to be able to make informed decisions.
My suggestion is to concentrate on the markets that strongly appeal to you, and then begin to collect the necessary data for trading. Fundamental analysis can be a good complement to technical trading, giving you extra confidence to know when to trade or help you avoid trading.
