Selection of Market or Set Of Markets for Trading, Timeframe and Trading session 

Selection of Market

In this article, we will focus on the practical aspects related to the selection of the market or set of markets that we recommend you choose for the development of trading strategies.

selection of market key takeaways

FOREX MARKETS

Over the years of experience in a hedge fund world, I have learned, together with my team, to focus on markets that give a systematic trader an unfair and real competitive advantage. This knowledge is based on the trial and error method and an in-depth analysis of these markets. 

Most traders focus on highly efficient markets such as forex—the reason why is pretty simple. When you look at online advertisements about trading, you will most of the time find out that trading “gurus” or brokerage companies are promoting forex. Why? Simply because the public demands it. But is that a reason to trade it? 

While the forex market is slowly becoming more regulated, many amoral brokers should never offer you their business. Yet, the opposite is the truth. It is objective to say that many scams in the forex market are no longer as pervasive due to tighter regulations, but some problems still exist. 

Probably the most known practice is when the forex broker offers too broad bid-ask spreads. Then it makes it more difficult to earn profits on trades, especially if you do intraday trading. If the forex broker is commingling funds or limiting customer withdrawals, it could be an indicator that something fishy is going on. 

There are many potential issues you might face when choosing the right forex brokerage company. It is essential to identify forex brokers who are reliable and transparent to avoid those that are not. But this is very hard to do. Trading is hard enough itself, but when a broker implements practices that work against the trader, making a profit can be nearly impossible. 

One example: I met a trader who found a very effective strategy making him excellent and stable profits. It was such a powerful strategy that soon, his forex broker realized that and ceased his trading with a ridiculous accusal of knowing something more than others. So he tried a second broker, third… In different countries. No matter where and which broker, it was always the same experience. Why? Most of the forex brokers operate under the market maker model, and these are the companies that have no interest in seeing you succeed as a trader in the long run. 

You ask why now. Isn’t their job to make money from commissions? Well, take into account that their goal is to access the forex market to smaller investors. That is the reason why we call them market makers. So they have to be ready to fill every order that you want to execute. And they do this by taking the opposing position of every trade that you make. 

And this is one of the secrets most of the forex traders don’t know: Every time you have a winning trade, they will lose money. 

Imagine that you bought the JPY/USD pair because you think that Yen is going to be appreciated. To make market access to you, the broker will have to take a position where they are selling JPY/USD. Since they are in a sell position here, their motivation is clear: To depreciate Yen in value or to see you lose on the trade. And bear in mind that your forex broker will never, ever reveal this to you.

The other type of forex broker business model is called an Electronic Communications Network (ECN). This type of forex broker is more customer-friendly. Consider that any broker’s ultimate goal should be to provide market access and, consequently, the liquidity. 

A forex market maker does this by taking an opposing position to every trade you place. On the other side, the ECN broker does this by routing your order through their network and matching it with another trade. So ECN brokers are your best choice if you want to stick with FOREX trading because these ECN brokers have no vested interest in seeing you lose money. 

Another solution for those not comfortable with market makers would be to trade with a real STP broker instead. An STP (Straight Through Processing) broker is a broker that is not a market maker. STP brokers are not liquidity providers, and therefore all trades placed with an STP broker are immediately passed directly to their liquidity provider(s).

As a middleman, an STP broker will profit from the difference between the spread they charge their clients and the spread they can get from their liquidity provider(s). STP brokers are called Straight Through Processing Brokers because all the trades placed with them effectively pass straight through them and into someone else’s hands. 

The issue with these brokers can be the quality of historical data (if they even provide them) and the quality of executions. Remember that I want to reveal the secret of systematic trading to you, and for these purposes, we always need high-quality historical data. 

Later in this Ebook, you will understand better what I mean by this. Based on many forex traders’ experience, it seems extremely difficult to find providers who would match all these conditions.

Futures Markets

Advice: Thanks to the Micro E-mini stock indices, FUTURES can also be traded in accounts in the thousands of dollars. It offers transparency and clean play compared to FOREX. Additionally, trading futures, you will come across interesting markets such as Platinum, Palladium, which are not as effective as Forex markets. Think about it!

When talking with experienced traders who have to go through these obstacles with FOREX, I always ask them why they don’t try futures trading? They always answered that the main reason is that the size of futures contracts is too large, and they need to have trading accounts in tens of thousands of dollars at least. 

Well, it used to be the truth, but things have changed with new market products – Micro E-mini Stock Indexes. 

On March 11, 2019, CME Group announced the launch of Micro E-mini futures on the S&P 500, Nasdaq-100, Russell 2000, and Dow Jones Industrial Average indexes. 

The new contracts are one-tenth of the size of existing E-mini futures. So, this is excellent news for small retail traders. Let me show you the equity curve for the strategy with the performance summary (Figure 1) for Micro E-mini Russell 2000 (M2K ticker):

Figure 1: Equity curve and performance summary for strategy on Micro E-mini Russell 2000, Performance Summary in TradeStation Platform

At 1/10th  the size of a standard E-mini contract, Micro E-mini futures give all traders a simple, cost-efficient way to access the futures markets’ liquid equity index. Instead of $8340 maximum drawdown and $159 480 Net Profit, we get $834 max DD and $15 948, so precisely 1/10th of the potential profit and risk from e-mini Rusell 2000. And that is something that makes futures trading very interesting for most retail traders now.    

What is the biggest advantage compared to FOREX trading? In my opinion, it is obvious. Transparency: In contrast to forex trading, futures markets provide the same prices, quotes, bid-ask spreads, and reliable brokerage services. Simply said, a futures broker can never be a market maker at the same time. 

A futures broker is just the intermediary between trader and exchange and makes a profit because of your trading volumes. Nothing more, nothing less. A significant difference to the forex broker who doesn’t want you to make money, right?  Yet, there are ways to trade forex transparently, and in our articles, we will try to cover this topic on our website.

 

Futures vs. Stocks Markets

But how about stocks vs. futures?

The problem with stocks is that you can face a short sale restriction. The short-sale rule was a Securities and Exchange Commission (SEC) trading regulation that restricted short sales of stock from being placed on a downtick at the shares’ market price. It is called the “up-tick rule”. 

The restriction helps keep short sales from driving down the price of a stock and stays in place for the remainder of that day and the following day. The purpose of the restriction is to promote stability in volatile markets while avoiding bear raids.

Moreover, if a stock falls 10% over the previous day’s close, it cannot be sold short. It is something you will never have to face with futures trading where you can short as many times as you wish without any restriction.

I am sure that one of the main reasons you want to be a trader is that you want to make money in a bull and a bear market. And when you cannot be sure if you can execute short trades, it is complicated to develop trading strategies you can trust. 

Another reason why stocks are not that interesting for many traders is that you are very limited to trade with margin. You cannot use the leverage that much like futures and FOREX. It can limit your potential returns but fortunately also your risk.

So as you can see, futures have significant advantages that make them appealing for all kinds of investors—speculative or not. However, highly-leveraged positions and large contract sizes make the investor vulnerable to massive losses, even for small market movements. The fundamental question is which futures markets one should focus on. 

As I said, for smaller trading accounts (size in lower thousands of dollars), we have Micro E-mini Stock Indexes (S&P 500, NASDAQ 100, Russell 2000, Dow Jones).

However, these markets are pretty efficient as they are very liquid, and it is more difficult to create truly viable strategies for these markets. On the other side, with a piece of good knowledge, you can still do that. It also gives a clear logic: when there is more competition, it’s harder to pick fruits from the trees. 

On the other side, some markets don’t provide that much liquidity. So big institutions with large trading accounts cannot allocate enough capital to them as they would need. In short, they can’t trade smaller markets with dozens and hundreds of contracts/units without creating significant slippages in their trade executions. 

I am talking about markets like Palladium, Platinum, Rough Rice, Orange Juice, etc. Except for Micro E-mini Stock Indexes, I try to target these markets because they seem inefficient. Big players are not interested in them, especially in short-term trading due to their trading positions’ limited potential sizes.

When a retail trader does his trading with a few contracts (for his trading account of thousands to hundreds of thousands of dollars), he has an unfair advantage. He does not have to worry about trading volumes. 

These inefficient markets are literally becoming a paradise for an intelligent retail trader who has the right knowledge by executing a small number of futures. And I want to share my knowledge and years of experience with you. It can save you your trading capital and time. You will not have to waste your energy when you know that you have almost no chance to generate meaningful strategies.

You probably see my point that we should look for the opportunities only when we know that there is an opportunity. Besides the right choice of markets, you have to be sure that you don’t trade randomly, and you have a trading strategy with a real edge. So let’s talk about this in detail now.

TIme FRAME

For the price bar charts on which we will develop the strategy, it is necessary to have their Time Frame defined. This can be, for example:

  • Monthly
  • Weekly
  • Daily
  • Minute (from 1min, 5min, 15min, 60min, 240min – in short, arbitrarily long inverval)

There are also alternative price bars that reflect the fulfillment of a certain volume of units. But for that, you need to have quality Tick data.

For example, at TradeStation, don’t even think about using this data, as they are skewed and can produce meaningless backtest results, and there’s high risk of being too optimistic.

  • Tick Bars
  • Volume Bars
  • Range Bars
  • Renko Bars

Many traders think, that it would be very easy to look for an edge in these alternative bars. We spent a lot of time with them. We had to find a database of tick data and shape these alternative bars ourselves, and we found that you would not find potentially more edge in them than in the classic minute bars. 

Although this concept of alternative bars is attractive to many traders, which we fully understand, the good thing is that using minute data will not ruin anything. On the contrary, you can be sure that you are working with relevant quality data if you work with TradeStation and decide to focus on US futures markets or stock markets.

We will work specifically with the E-mini Russell 2000 (ticker RTY) and the Micro E-mini Russell 2000 (ticker M2K). These are identical markets, with the difference that M2K is 10 times smaller, so it is more suitable for traders with a very small capitalization in the thousands of dollars. As a timeframe, we choose a 60 minute bar (i.e., 1 hour, if you will) (Figure 2). 

According to experience, this stock index offers very good opportunities for the development of potentially interesting strategies. So again, we are talking purely about practice.

Figure 2: 60min chart for E-mini Russell 2000 (RTY), Source: TradeStation Platform

Time Session

Stock indices are traded basically non-stop during the week, but night sessions often do not offer the required liquidity. Besides, we have found in practice that it is better to focus purely on the main trading sessions, but there is nothing against adjusting the time frame. 

Futures stock indices are traded on the Chicago Stock Exchange. In New York on the stock exchanges, the main trading hours are set from 9:30 a.m. to 4:00 p.m., which is the time in Chicago from 08:30 to 15:00, i.e., for our chosen E-mini Russell 2000. From our own practice we know that it is better to omit the beginning of the main trading sessions for futures. 

They tend to have very high volatility and with it proportionally higher slippages. Therefore, we will use our own session from 08:45 a.m. to 03:03 p.m. Why 03:03 p.m.? If any of the built strategies appeared directly at 03:00 p.m., at close time, we would again be in danger of very high slippages in the trading market order. This is a proven practice, take it seriously.

TradeStation has the great advantage of being able to form candles for a trade session you have defined, and if it does not match the defined time frame, it will always cut off the last candle at the end of the session. 

In our case, a 60 min time frame will mean it will form a bar from 08:45 a.m. to 09:45 a.m., from 09:45 a.m. to 10:45 a.m., ……, until 02:45 p.m. to 03:03 p.m. The last bar will therefore have a range of 18 minutes instead of 60 minutes. We will then set up the trading session on the platform in the section: Format – Format Symbol – Custom Session (Figure 3).

Figure 3: Custom session  for E-mini Russell 2000 (RTY), Source: TradeStation Platform

Advice: Work with minute data for futures and intelligently create your own trading sessions. Get rid of alternative bars, they won't bring you anything.

In the next articles, we will be developing a strategy for the (Micro) E-mini Russell 2000 market, with a 60-minute timeframe and a session from 08:45 a.m. to 03:03 p.m. Chicago time. 

But before doing that let’s cover trading platforms.

If you don’t want to read all I want to share with you article by article, grab our Ultimate Guide To Successful Algorithmic Trading here and read it anytime you want! 12 chapters, 112 pages: all in one place and completely FREE of charge! 

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