For new traders, one of the most challenging decisions can be selecting a futures contract to trade. There are many factors to take into consideration including:
1. What is the margin requirement?
- Margin requirement is the amount of capital required to trade a futures contract
- Most traders choose to fund your futures trading account with 3 to 4 times the contract’s margin requirement
2. What is the spread?
- The spread is the price difference between the bid and ask
- The spread will determine how ‘expensive’ it will be to enter or exit a futures position
3. How does liquidity affect the contract?
- Futures market liquidity represents the stability of interest by traders to buy and sell that contract
- Increased liquidity will cause the spread to tighten as there is more interest in the contract
- Decreased liquidity will cause the spread to loosen as there is less interest in the contract
- The more ‘liquid’ the contract, the less it will cost to enter and exit the market for that particular contract
4. How consistent is the daily volume?
- Predictability on any scale could provide an edge when trading futures
- Volume fluctuations or inconsistencies above or below the historic average can serve as an indicator of price movement
- Contract trading volume could impact the spread: low volume, the spread may be wider, high volume the spread may be narrower
Once you have identified a few contracts that fit the parameters you are looking for based on the questions above, the next step is backtesting.
Backtesting allows traders to ‘test’ their trading strategy versus historical data to get a sense of potential performance. By using trading indicators such as Bollinger Bands or the Relative Strength Index (RSI), you can get some additional insights to help fine tune your strategy…or identify new potential opportunities. As always, be aware that past performance is not necessarily indicative of future results.
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