Here’s the next installment in the trading plan sequence of posts I have been running over the last week or so. This one focuses on knowing the market(s) you are going to trade. Again, this material is primarily excerpted from my book, The Essentials of Trading.Â
Step 5: Market Knowledge Assessment
By going through the assessments in the last couple of steps (time and expectations) one should start getting an idea what market or markets are best suited for the kind of trading being formulated. The table below will help narrow the focus a bit further.
The question then becomes one of knowledge of and comfort with the markets on the list of prospects you develop. It is always easiest to trade in a market where there is a firm understanding of the operations and the instruments in question. In such a circumstance the trader can focus on other things. The trader looking to work in a market new to them, however, has a learning curve to overcome first and foremost.
Picking up the basics of any given market and/or instrument is fairly easy, as there are plenty of resources in that regard. Getting comfortable, however, is often more a question of experience and observation. That takes more time.
Before one trades a market, certain things need to be understood.
- Addressing the point from Step 3, the trading day should be known. Foreign exchange is still the one true 24-hour market, but several others have closed the gap. Even in forex, though, there are times of day, especially in certain currency pairs, when trading is thin. The longer-term traders might not concern themselves with this sort of thing, but it is vitally important for shorter-term participants to be aware of these sorts of liquidity and volatility considerations when choosing a market for trading.
- In consideration of the questions raised in Step 2, the capital requirements for effectively trading a market are important to understand. Many markets these days can be traded with small accounts, but that does not necessarily mean one can have a reasonable expectation for performance. Transaction costs can be an important consideration, and margin requirements have an impact. A poorly capitalized account can severely hamper performance, so it is important for the trader to operate only where the risk capital available is sufficient to trade well.
- Taking into consideration points raised in Step 4, the trader must understand the instrument(s) being traded in terms of price increments. Stocks are easy in that a 1 point movement in share price is $1 per share. The futures markets are considerably more diverse in terms of contract specifications and point values. Forex pip values vary according to the market rate and the size of the position. In order to understand both risk and expectation, it is important to know these values. It is also very important to have a good idea of the kind of price volatility which can take place in the instrument(s) being considered during the anticipated timeframe.
Refer to other posts on this site for more information on the various markets.
Look for the next piece in the sequence on Monday.
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About the Author
John Forman, author of this blog, has traded for more than 20 years, is a professional market analyst, and authored The Essentials of Trading. He is an active participant in trading forums, consults for trading related businesses, as published literally dozens of trading articles, and has been quoted in a number of books and in the media.
** See John’s full bio.
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