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Professional Trader Series: The Art of Portfolio Selection

  • Brent Penfold
  • 20 July 2016

Professional trader and author of The Universal Principles of Successful Trading (Wiley 2010) now translated into German, Polish, Japanese, Korean and Simplified Chinese.

The fifth step in the process of trading is to select an appropriate market or portfolio of markets to trade.

This brief note will resemble more of a checklist then an article. I'll run through a number of attributes which I believe makes a good market for trading. The more attributes a market satisfies the better, in my opinion, it will be to trade.

Price and Volume Transparency
If you can't see all the volume being traded at each price point then transparency doesn't exist. Trading is difficult enough without seeing all the activity going on.

Liquidity
Once you have established that a particular market is fully transparent on volume and price activity the next most important attribute is liquidity, the amount of volume traded. Simply put, markets with higher volume should be preferred to markets with lower volume. Higher volume means there is less chance price signals can be distorted by manipulative behaviour. The larger the volume the more true a market is. Higher volume also means less slippage on entry and exits. Less slippage means more profit.

24-hour Coverage 
The benefit of 24-hour markets is that you can have your stops working when you're asleep. It's a great benefit to enjoy if a catastrophic event occurs out of hours.

Volatility
Markets need to move for traders to make money. A flat line market offers nothing. Look for volatile markets, don't shy away from them, learn to embrace the opportunities they offer, remember you are a trader after all.

Historical Data for Research
To trade without research is to gamble. A good market to trade is one with a minimum of 10 years of historical data.

Portfolio - Single/Few Markets
Traders with smaller accounts are forced to focus on one or two markets as their risk capital is limited. The indices and currency markets are ideal for smaller account traders as they satisfy the majority of the above attributes.

Portfolio - Multiple and Diversified Markets
Traders with larger accounts who can afford to monitor multiple markets should look to trade a portfolio of diversified markets.

As a starting point, the following portfolios could be considered.

These markets meet the majority of the above attributes with "liquidity" being the dominant selection criteria.

They are the most liquid futures contracts traded on the Chicago Mercantile Exchange within their market segment. And this is VERY IMPORTANT. These portfolios and markets are based on their attributes with "liquidity" being the dominant one. These markets have not been chosen based on any trading methodology's equity curve. They have NOT been chosen because they suit any particular trading mode (trend trading or counter trend trading) or trading timeframe (day, week, month, quarter etc). They have purely been selected based on their attributes.

Please remember this. DO NOT select a market because it makes your strategy profitable. If you do that then you will be curve fitting your market to your strategy. It's best to select a market because it exhibits the majority of good trading attributes and then hope your methodology is good and robust enough to generate a positive expectancy. If it doesn't then don't blame or change the markets, blame and change your strategy.

Below are two portfolios. Each portfolio is diversified as they contain markets from different market segments. The 16 Market Portfolio contains the two most liquid futures contracts within each segment.

Segment &

8 Market

16 Market

Market

Portfolio

Portfolio

Currencies

 

 

   Euro Currency

x

x

   Japanese Yen

 

x

Indices

 

 

   S&P500

x

x

   Nasdaq

 

x

Financials

 

 

   10Yr T-Note

x

x

   5Yr T-Note

 

x

Softs

 

 

   Sugar

x

x

   Coffee

 

x

Grains

 

 

   Corn

x

x

   Soybeans

 

x

Meat

 

 

   Live Cattle

x

x

   Lean Hogs

 

x

Energy

 

 

   Crude Oil

x

x

   Natural Gas

 

x

Metals

 

 

   Gold

x

x

   Copper

 

x

These portfolios are by no means exhaustive; however they do provide a reasonable starting point for traders looking to build a portfolio containing multiple and diversified markets with good trading attributes.

http://www.indextrader.com.au/