Liqjuidity Matters

Many people have the erroneous idea that liquidity equals high volume or large Open Interest. I don't disagree with this idea, but I believe that good liquidity also requires a second component -- tight spreads. When I chose which futures instruments I will trade, I look for two things:

1. One of my mentors taught me not to trade any futures instrument that has Open Interest less than 10,000. However, over time, I decided to tighten my restrictions even more. I won't trade any futures instrument with Open Interest less than 100,000. This requirement creates a fair short list of trading instruments for me.
   
2. I also add a second criteria. I won't trade any futures vehicle with a spread of more than 1-2 ticks. During the day session, I won't trade any futures instrument with a spread more than 1 tick, but during evening trading, I won't consider anything with a spread of more than 2 ticks. I believe that any else is financial suicide. Fortunately, trading with the CME and CBOT, there are a fair sizable number of futures than have spreads of just one or two ticks. I will consider trading futures on a longer-term basis that have tight spreads but relatively low volatility, including some of the "other futures" that I mentioned in one of my earlier posts today.
   

Untradable Grains

Grain charts are too erratic for me to trade profitably today. When this happens, I read a book and watch the charts. When the charts begin to look right to me again, I'll begin to trade. Until then, I watch and wait.

I watch for three conditions in order to trade:

1. Tight spreads. On this measure, soybeans and corn are fine. Wheat spreads haven't widened to the point that I won't trade them.
   
2. Sustained, reliable movements, either up or down. This is hard to describe, but I know what it looks like. Perhaps the term market noise is a good way to describe poor trading conditions. Right now, the charts don't look right.
   
3. Volatility. Without volatility, it become worthless to try to trade because the risk/loss ration is too high and profits can't be obtained.

Commodities Broadly Higher, Primer on Commodity Indexes

Commodities in general are broadly higher today. I have been reading over the weekend about the various different indexes used in creating different commodity indexes. Here is a very good primer on the various different ways that ETF companies calculate and manage the commodities in their indexes. It is published by Deutsche Bank in conjunction with the Proshares ETF family, which it sponsors. Obviously, any ETF provider is going to favor its own methodologies of selecting and managing commodities. In light of this bias, it makes sense for any investor to carefully study the available published material and weight that bias against the available data. However, after reading DB's primer (not light reading, but interesting and educational nonetheless), I admit a bias for the DB/Proshares products myself. They are probably the most liquid of all commodities ETFs, consistently maintain the tightest spreads, and make a very strong case for their methodology being the best for investors. See what you think after reading their brochure regarding the many different commodity indexes. I have also included two links to other index-related materials.

Deutsche Bank Guide to Commodity Indexes

DBLCI - OY: Technology to Tackle Term Structure Dynamics

DBLCI: Less is More

Trading Smooth as Glass

Trading this evening has been just as smooth as glass, although I have been somewhat disappointed that liquidity and spreads haven't been better. Look how smooth and easy this chart has been to trade. I couldn't ask for better trading conditions. It reminds me of when I was young, and we used to look for water skiing conditions on water that was smooth as glass. Tonight was like that!

Soybean sell-off at the end!

There is almost always a reversal in soybeans at the end of the day as traders take their profits. Many people, including me, don't like to carry trades over the weekend. Many others are day-traders, and liquidate all trades before the close of the day's market session. I like to use this as a way to make additional profits. Thus, I usually execute my last trades between 12:00-12:05 MDT (my local time zone in the Salt Lake City vicinity).

Today, the market began its sell-off about 17 minutes before the market close. That's when I made my last trade. This is prime trading time, since market moves at this time are almost always very smooth and uni-directional. These are some of my best and most reliable trades, too. This is also a time when large funds and hedgers must liquidate quickly to take their profits, so small traders like me can use this to our advantage. I take advantage of these opportunities, closing out my last trades only 2-3 minutes before the session ends at 2:15 EDT. The pictured trade was worth almost $200 per contract, and occurred in only 15 minutes. Just look at how clean that trade was!

I might add, however, that I have NOT found that the market open is equally profitable. The market often moves so rapidly and erratically that it is difficult to trade profitably. I usually wait 5-10 minutes into the trading session before placing my first trade. This is not always the case, but is a general rule for me.

Evening trading can also be profitable between 7:30 - 9:30 pm EST. I ONLY trade using tick charts during these hours. Unfortunately, however, spreads also widen; the bid/ask spread is usually 2-3 ticks during these hours, so they can entail higher risk as well.