Choosing a Market to Trade

Trading the markets is, potentially, a great way to grow your capital, as long as you learn how to invest properly and have a good system to manage your risk whilst maximising your profits.  An individual setting out to do so needs to :-

1.    Know the market that they wish to trade.

2.    Understand how to determine the opportunities available through technical analysis.

3.    Have the funds with which to do so and know that this could be lost without any danger to their current or future lifestyle

4.    Know how to control risk.

5.    Have a plan.

Considering these five points will help to determine the market to trade so let us take each one in turn.

If the individual has been a successful investor in a particular market then, on the face of it, they are in a strong position to be able to trade it.  However if their investing was long term, as measured in years, they will need to have a different approach when trading as the information needed and the psyche involved are quite different.  It may be better to choose a market that they are not familiar with as they are less likely to be influenced by long term thinking getting in the way. If they choose to go with the market they understand then ready access to information about the market will be essential as will be the time to read and analyse it.  If the market chosen is equities then company announcements and economic statistics relating to the wider economy as well as the specific company must be readily accessed. Shorter term traders will need the information to be in a timely fashion because markets react very quickly to anything that influences the perception of value.

Choosing a market that they are not familiar with, however, then requires a good knowledge of technical analysis.  True technical analysts can trade any market that they have the data of price and volume for. It is also entirely possible to trade markets without a deep understanding of technical analysis. Indeed too much knowledge by way of indicators that seek to further analyse the raw data can get in the way and make a simple decision very complicated, confused and wrong. By with the right training technical analysis can be a very powerful way to trade.

Some markets are more volatile than others but all represent a high level of risk so that the market chosen may be determined by the level of risk and funds available to the potential trader.  Commodities and Foreign exchange markets tend to be very volatile and may represent the higher risk markets.  Sometimes the trader will need high minimum stakes which makes it impossible to manage risk efficiently without having large initial levels of funds.

Managing risk is absolutely essential for anyone to be a successful trader.  This involves two elements in the managing of the trader’s funds.  First of all they must limit the amount that they risk on any one trade so that they cannot be wiped out by one rogue trade.  Trading involves many lost trades and, usually, fewer winning trades for most traders.  So the approach is to ensure that the expected gain exceeds the potential loss on each trade by a significant margin. Losses should be limited by the use of a stop loss on every trade.  The margin or deposit required will be based on the risk that the trade represents and the amount that is to be traded per unit.  All of these are considerations in choosing the market to trade as they may be beyond the sensible use of the funds available. They do, however, allow the trader to ‘fall asleep’.

So what markets are available to be traded? The equity market in the UK and overseas, foreign exchange, commodities are all available and are widely used. 

In the equity market there is a choice of individual companies and indices.  It is possible to gain exposure to specialist areas with the use of ETFs (exchange traded funds) which can offer exposure to global areas such as Asia, Emerging Markets, Europe, America and others. 

ETFs can also be used to gain exposure to commodities such as particular metals eg nickel or copper or the precious metals of gold and silver.  Exposure to soft commodities such as wheat, coffee and soya etc. can also be gained in this way.  Commodities whether they be soft or hard are the subject of many influences that are often hard to predict and can be very volatile as a result.

The foreign exchange market is the largest market in the world with some $4trillion dollars traded every day.  It is the market that is most closely associated with the pure form of technical analysis because of the large amount traded each day.  Even so, as the trade is in currency pairs it is the major currencies that best fit as smaller currencies are less widely traded and be more likely to be ‘surprisingly’ volatile.  Individuals that are new to trading will often pick this market as it usually offers opportunities every day and the choice from a list of major currencies is considerably smaller than the choice within the equity market.  The spreads (difference between the buying and selling price) are generally smaller than they are in other markets and prices are volatile enough to be able to make a profit (or loss) each day in each currency pair.