Last time we discussed changing our market stall when our current product range is no longer in favour with our customers.  That is a great analogy to the situation we face in the markets today.  The S&P is completely untradeable at the moment, has been for quite some time now and quite possibly will continue to be like this for a while longer.

So we know we need to find a more fashionable product, one that people are actually interested in.  But how do we choose that product?  That’s what I want to go over today.  Here is how I answered that question myself over the last few weeks…

The first question to ask is – “What attributes make for an attractive market?”

My answer to this is 4 things – “Volume, volatility, clean behaviour and personal preferences.”

Let’s tackle volume and volatility together, as these will both be present in an ideal market. Volume is all about the ease of getting orders filled vs. giving up the bid-ask spread (and more often).  Volatility is about sufficient movement to make worthwhile profits.  Individually they are less helpful.  Take for example Eurodollars and Natural Gas.  Eurodollars have huge volume but are totally inappropriate as they don’t move.  Natural Gas is the opposite.  No one would argue about the volatility in Nattie, but its volume is less than ideal, especially as it tends to suffer from “air pockets” where the volume is discontinuous.  If you have ever been stopped out in this market and your stop was within an air pocket you will know exactly what I am describing here!

So what short of markets list can we come up with which have both volume and volatility?  I looked at 4 markets – Gold, Crude Oil, British Pound and Euro (currency).  These are all high volume markets with decent volatility.  There are others too but they also fall within the same groups – metals, energies and currencies.  So I would prefer to concentrate on the “leaders” within each group (that’s my first personal preference creeping in).

My third attribute I call “clean behaviour” which is qualitatively the way a market moves in relatively clean swings and waves versus lots of spikes and sharp movements etc.  This is about maintaining decent risk/reward ratios, i.e. not having to use unreasonably wide stops for fear of quick spikes.  Using this as a selection criterion, the currencies seemed most attractive, Crude the least attractive and Gold somewhere in the middle. I wouldn’t rule any out based on this alone but it helps in starting to prioritise them.

Now let’s talk about preferences.  For me there were two things I wanted to consider (a) time zone and (b) dependence on speculators. In terms of time zone my ideal would be to be able to trade during either or both of the main European and American sessions, to give me flexibility in my day.

The second is more vague and based on no more than a gut feeling I have that people have considerably less appetite for speculation than they used to have.  If there is any validity to this it is probably due to a combination of the economic environment plus the recent memory of markets in meltdown.  Neither of which is going to subside for some years.  The evidence is the total lack of volume in the stock market, which is a purely speculative market after all.  So ideally I would choose a market that has little dependence on speculation for its volume.

These factors again put currencies in a more favourable position than Gold or Crude.  The volume in the currency markets is predominantly reliant on international trade.  Whereas Gold has not been driven to its current levels just be people wanting to make jewellery for sure!

So having homed in on the currencies as being the more likely candidates, is it the Pound or the Euro?  Actually this was an easy decision.  The Euro has considerably higher volume, especially during the European session.  In addition the contract size is twice as big and hence would consume half the brokerage and execution costs.

So just to get back to where we started, having identified the Euro as our prime candidate, how does volume and volatility look?

I looked back at the last few weeks, breaking the day into 30 minute segments to examine the average volume and average range within those periods.  In case you are wondering why I used a small sample size it is because I am only interested in what is happing now and not what happened 3 years ago etc.  Take the S&P as an example, you would get great stats looking back 3 years but it would not reflect what is happening today at all.

During the European session (within which I like to trade 7:30 – 11:30am UK time) the Euro is typically trading 5000 contracts and a 20 point range per 30 minute segment.  This is perfectly tradable and is actually very impressive for a Chicago listed contract in the middle of the American night.

The American session (within which I like to trade 1:30 – 5:30pm UK time) sees a slightly better range of around 25 points combined with the obvious explosion in volume that would be expected.

These are clearly great trading environments during both sessions and not too surprisingly we have selected the Euro as our main market whilst taking great delight in kicking the S&P into touch for the time being.

There is also one other factor that makes the Euro attractive.  Like all currency markets it is predominantly a cash market (circa 95% cash), with derivatives being miniscule “add ons” that have no influence whatsoever on the market.  So the futures, which we prefer to trade, simply track the cash.  Therefore we don’t have to worry about events such as contract rollovers, option expirations etc, which can have significant impacts in the stock market for example.  The currency markets don’t give a damn about such things, so we don’t have to either.

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