Education

Trading Strategies: Picking the Right Market

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A quick primer for newbies looking to get into trading. Although it seems possible at first glance, you cannot trade in every market. Period. Particularly with limited capital. And unless you’re part of some sort of hedge fund or PE firm, you will have limited capital.

It is especially critical to choose a market that is appropriate and commensurate with your initial amount of capital, otherwise the chances of getting a permanent setback that wipes you out are high.

Risking too much is not a good start

It may seem very obvious, but I assure you that it is not something many traders stop to appreciate early on. If, for example, one has received training based on the Futures market of S&P, one naturally chooses this market when deciding to trade with real money (as opposed to virtual trading).

And deep down, there appears to be logic to this decision. After all, it is a market in which many hours have been spent, and that implies a knowledge of the behavior of this market and its participants that surpasses the knowledge one may have with respect to other markets. But do not forget the famous 1% rule (that is the maximum risk that one must assume on his account in each trade).

If the mini-S&P has a tick value (minimum price movement) of $12.50, that implies that, considering that no one who is starting in trading may consider trading with stops below 10 ticks in intraday, the minimum risk that will be assumed in each trade will be $125.

And as you have already done the calculation quickly, to risk only 1% of your account, you will need it to have at least $12,500 to consider trading under reasonable conditions. I can assure you that a high percentage of traders leave their training and begin to trade that market with accounts sometimes even lower than $5,000.

That can not be done? Of course it can be done, but it is not recommended at all, much less in the initial stage of a trader. The risk that is going to have to be assumed by trades will be high (in the event of having $5,000, the risk per trade is 2.5%). That means that 40 negative transactions completely melt your account. That figure is not acceptable for a “rookie,” and the chances of getting scared of trading at the first sign of negativity are too high to even consider.

How do I choose the market to trade?

The market that you are ready to trade must meet two requirements. The first of them is the necessary condition that I have just explained: you must be able to bear with ease the losses based on your initial account. Divide your account between 1000 and you will have the maximum tick value that you can assume in a futures market.

In the example above, if your account is $5,000, you should find a market of $5 a tick, such as the mini-Dow or mini-Nasdaq, for example.

The second requirement points precisely to the real possibilities of obtaining interesting returns: the chosen market must be volatile and offer frequent trading opportunities. If a market is viable because it meets the first condition, but nevertheless offers short and unclear movements, it will not interest you.

This second requirement will require some time to study your movements and the opportunities it offers to fit your trading system into different time scales or ticks of the new market. But it is an exercise that can determine your success or failure in trading.

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