Beginner Trading Fundamentals: Popular Trading Instruments
Because traders rely on small price movements for profits, there are two important factors to consider when deciding which instruments to trade: liquidity and volatility. To review, liquidity describes the ability to execute orders of any size quickly and efficiently without causing a significant change in price. In simple terms, liquidity refers to the ease with which shares (or contracts) can be bought and sold. Liquidity can be measured in terms of:
- Width - How tight is the bid/ask spread?
- Depth - How deep is the market (how many orders are resting beyond the best bid and best offer)?
- Immediacy - How quickly can a large market order be executed?
- Resiliency - How long does it take the market to bounce back after a large order is filled?
Markets with good liquidity typically trade with tight bid/ask spreads and with enough market depth to quickly fill orders. Liquidity is important because it helps ensure that your orders will be:
- Filled with minimal slippage
- Filled without substantially affecting price
Volatility measures the amount and speed at which a price moves up and down. When a trading instrument experiences volatility, it provides an opportunity to profit from the change in price. Any change in price - whether rising or falling - creates an opportunity to profit; it is difficult to make a profit if price stays the same.
You can get a good idea about an instrument's liquidity and volatility by looking at:
- Average daily trading volume (ADTV) - the average number of shares or contracts that are traded in a day or over a specified period of time. When ADTV is high, the instrument has good liquidity and can be easily traded.
- Average daily trading range - the average difference between the high and low prices for a given instrument over a specified period of time. A wider trading range equates to more volatility, which, for traders, means greater potential for profits (and losses).
Volume indicators can be added to any price chart; volume typically appears as a histogram beneath the price chart. Each bar of the histogram represents the volume that occurred during the corresponding price bar. For example, if you are trading with a 5-minute chart, each price bar shows the price movement that took place during that 5-minute period, and each volume bar indicates the trading activity for the same period. A moving average can be added to volume to determine the average values. A 20-day moving average, for example, would show the average daily trading volume over the previous 20 days.
The average daily trading range shows how much price movement there is, on average, over a selected time period. This value can be determined by calculating the difference between the daily high and low prices over a specified number of days. An easy way to do this is to apply a moving average to a daily chart that uses the high-low price (rather than just the high or low) in its calculation. The length of the moving average will determine the number of days that are used in the calculation.
Most traders choose instruments that trade under good liquidity and with enough price movement to allow profits. That said, just because the e-mini S&P 500 (ES) contract fits that bill, doesn't mean it will be appropriate for your trading style or risk tolerance. Finding an instrument that matches your style may take a bit of research. As a starting point, these instruments tend to be popular among active traders:
Commodities are typically bought and sold through futures contracts on exchanges that standardize the quantity and minimum quality of the commodity being traded. The main categories of commodities include agricultural, livestock and meat, energy, precious metals and industrial metals. The most actively traded commodities include crude oil and its derivatives (i.e., heating oil and gasoline); precious metals; and agricultural products such corn, sugar, soybeans, wheat, coffee and cotton.
An "e-mini" is an electronically traded futures contract that represents a portion of a standard futures contract. As futures contracts, the e-minis represent an agreement to buy or sell the cash value of the underlying index at a specified future date. The contracts are sized at a certain value times the futures price; this value depends on the particular e-mini. The e-mini S&P 500, for example, has a contract size of $50 times the e-mini S&P 500 futures price. If the value of the e-mini S&P 500 is $1,320, the value of the contract is $66,000 ($50 X $1320). The value of the contract changes as the price of the futures moves. Mini contracts are available on a variety of products; however, traders typically refer to the e-mini stock index futures contracts when discussing e-minis: the e-mini S&P 500 (ES), e-mini Russell 2000 (TF), e-mini Dow (YM) and the e-mini Nasdaq 100 (NQ) contracts.
Exchange Traded Funds
Exchange traded funds (ETFs) are uniquely structured investment funds that track broad-based or sector indexes, commodities and baskets of assets. ETFs trade just like stocks on regulated exchanges and can be sold short and purchased on margin. And, like stocks, ETF prices fluctuate throughout each trading session in response to market events and investor activity. Some of the most actively traded ETFs include SPDR S&P 500 (ARCA:SPY), MSCI Emerging Markets Index Fund (ARCA:EEM), S&P 500 VIX Short-Term Futures ETN (ARCA:VXX), Financial Select Sector SPDR (ARCA:XLF), Russell 2000 Index Fund (ARCA:IWM), MSCI Japan Index Fund (ARCA:EWJ) and PowerShares QQQ Trust (Nasdaq:QQQ).
Forex is the foreign exchange market where currencies are traded. The forex markets are the largest and most actively traded financial markets in the world, accounting for more than $4 trillion in average daily volume. Forex is appealing to many traders and investors for a variety of reasons including its relative stability, its round-the-clock nature and access to significant leverage. The four pairs that are the most heavily traded are known as the "majors." They include the euro/U.S. dollar (EUR/USD); U.S. dollar/Japanese yen (USD/JPY); U.S. dollar/Swiss franc (USD/CHF); and the British pound/U.S. dollar (GBP/USD).
Stocks are a type of investment that signifies ownership in a company. The number of companies in which investors and traders can buy stock has been steadily declining over the past decade as firms are delisted, go private or are bought out. In 2000, for example, there were 6,639 listed stocks; by the end of 2012, that number had dropped to 3,687. Despite the shrinking list of publicly traded companies, stocks continue to be popular among active traders because of their liquidity. The actual trading volume varies day to day; however, certain stocks including Bank of America (NYSE:BAC), Zynga (Nasdaq:ZNGA), Sirius XM Radio (Nasdaq:SIRI), Ford (NYSE:F), Standard Pacific (NYSE:SPF) and Intel (Nasdaq:INTC) tend to hang out at the top of the list.
Treasuries are negotiable U.S. government debt obligations backed by the full faith and credit of the United States. The four that trade with the most volume are the 10-Year Note, 30-Year Bond, 5-Year Note and 2-Year Note. There are also exchange traded funds available that provide exposure to government debt markets, including the iShares Barclays 20+ Year Treasury Bond (ARCA:TLT) and the ProShares Ultra Short 20+ Year Treasury (ARCA:TBT).
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