What’s the best market to trade?

 

When you log into a trading account, there are often hundreds of markets to choose … from huge forex instruments to tiny small caps, or from precious metals to more obscure things, like lean hogs and orange juice …. But what’s the best market to trade ?

It’s easy to think that, as long as you have a winning strategy, you should be able to apply it to any financial market …

But different markets behave very differently … and a system that works great on the FTSE might be a disaster trading the Japanese Yen, or vice versa.

That said, some instruments are fundamentally ‘kinder’ to traders than others.

Here I’ll look at the best markets to trade and why …

Five factors to help you choose the best market to trade

1. Liquidity

Liquidity … has been the buzz word for brokers and ‘experts’.

Liquidity matters because it describes how easily a market can be bought or sold at stable prices. If you want to sell … you’ll need to be able to find a buyer. If you want to buy … you’ll need to be able to find a seller.

If there’s a lack of liquidity, you may not be able to get into or out of trades at the moment you want to.

Liquidity is great for your broker, who needs to balance large positions. But it’s importance to the little guy is often overplayed. Don’t be fooled into thinking that stepping outside the planet’s most liquid market (Forex) will leave you struggling to find buyers or sellers for your positions.

Unless you’re trading with £millions, this shouldn’t be a big issue for you. I’m not suggesting that you start trading obscure corners of the market, exotic currency pairs, or tiny small caps – but indices and large cap companies offer plenty of liquidity for our needs.

But the really good thing about liquid markets is tighter spreads – which brings me on to costs …

2. Costs

A quick look at my broker this morning, and I can see spread costs ranging from 0.6 for EURUSD, to 50 pips for USDMXN (I’ll talk about margin requirements on markets like this in a moment).

Unless you have a really good reason to be in that particular market, there’s no sense in paying a wide spread that you don’t have to.

So, if your trading strategy works across major Forex pairs, why pay a spread of 3.8 pips to trade GBPNZD, when you could be paying 0.6 pips to trade EURUSD or EURGBP or AUDUSD?

Every point in spread you pay means that the market has to move a point further to make a profit – and that makes it harder for your strategy to be successful. The odd point charged here and there may not seem like a big deal, but look at it as a ratio of your profit target.

For example, if you’re looking for a 10 pip move on a trade, and you’re paying 2 pips in spread costs – that 20% of your profits eaten up by your broker.

By contrast, if you’re looking for a 200 point move, and you’re paying 5 points spread, that’s just 2.5% you’re giving to your broker.

I’d urge you to look for cheaper markets – and shop around brokers for the best deals.

3. Margin

The cost of trading is more than just the spread you’re paying to your broker. There’s also margin requirements.

The easiest way to think of margin is like a deposit paid to your broker when you place a spread bet or cfd.

Margin is calculated as a percentage of the size of the instrument you’re trading, so (in general) more expensive instruments will have greater margin requirements. (The point being that they have further to fall.) However, the percentages used to calculate the margin vary from instrument to instrument.

Major FX	3.33%
Minor FX	5%
Major indices	5%
Minor indices	10%
Gold	5%
Other commodities	10%

Margin requirements aren’t the same as the ‘risk’ on a trade, which should be managed with stop levels. But what margin does mean is that you need to have sufficient funds in your account to cover these costs. And if you’re running multiple trades at the same time, it can mean having a lot of capital tied up.

Successful investing is all about making the money we have work as hard as possible – so tying it up in margin requirements isn’t ideal.

So, if we’re after low-margin instruments, we want to look at instruments that are smaller in scale and that have a low margin percentage requirement. Here are some good (and not so good) examples …

The French CAC stock market is trading at around 6000. It’s a major index, so the requirement is 5%. This means the initial margin requirement to trade this at £1 stakes would be £300.

We looked earlier at the spread costs of trading the US dollar against the Mexican peso (USDMXN). So what would the margin requirements be on that? The exchange rate is 18.7000, and the margin requirement is 5%. This means that a £1 spread bet would have a margin requirement of £9,350! (If the 50 pip spread didn’t put you off, I expect that margin would!)

By contrast, EURGBP is a major Forex pair, trading at 0.8440, meaning a margin requirement of just £281 for each £1 staked.

Margin can be a bit tough to get your head around – essentially we want to avoid obscurer markets, and markets that are very large (unless you have very deep pockets). You can get lots more information on margin trading here.

4. Volatility

Before you scour the instruments on your broker’s platform for the smallest one with the tightest margin requirements … consider volatility.

To make money from the markets, those markets need to move.

The more they move, the bigger the profit opportunities available.

Volatility is a measure of the size and range of a market. Trading strategies need enough volatility to run to our targets, but not so much volatility that we get bumped out of trades all the time, or need to trade with wider stop levels that we’re comfortable with.

Size and average range of the market also needs to fit with the strategy you’re using, and won’t necessarily transfer directly from one market to another. Some markets might be very expensive, with a tight trading range … while another can be cheaper, but much more volatile. Watch the market, look back through the charts, to get a picture of how it moves.

Remember that volatility in a market changes over the course of a 24 hour period too – with key times bringing in surges of activity, while overnight periods tend to be quiet.

Also, consider that if you’re looking for very small moves on a market, you’ll probably want to have a higher stake – and that’ll bump up your margin requirements.

5. Transparency of information

You should have some understanding of what influences prices on a market you’re trading.

Because of the scale and the nature of forex markets and indices, information moves freely and prices will be affected according to news stories, speculation, fear, greed … all the normal stuff.

But with markets like commodities and single stocks, small news stories can move prices significantly – things that little guys like us can’t expect to keep up with. A refinery going offline could bump up oil prices … internal company politics could crash its stock price … an outbreak of swine flu could cause pork belly futures to go up … all these things can move prices, making the process of predicting these moves very opaque for outsiders.

So, taking these five factors into consideration …

So, what’s the answer? What’s the best market to trade?

Obviously, it’s important to match your trading strategy and your markets, but my favoured markets are major FX and major indices, but exercising caution around the more expensive markets, like Wall St and the German DAX, unless I have a good reason to be looking at those instruments.

Some ‘Goldilocks’ markets for me are things like the French CAC and EURGBP, both of which are cheap, with reasonable volatility.

Whatever market you’re considering, it’s vital to test out your trading strategy on it before committing. Sometimes, despite ticking all the boxes, it just won’t work, for reasons that can be difficult to fathom.

I’d urge you not to go hunting for the ‘perfect’ market, but instead opt for the most practical. They can all be fickle and hard to predict, but the more you trade a particular market, the more attuned you’ll get to its quirks and tricks. If you’ve markets that you’ve found particularly suited to your trading, I’d love to hear about it in the comments section below …

 

To enjoy more content and get it faster Follow @TradersBulletin