There is no shortage of futures contracts to trade as there are numerous high quality exchanges offering highly liquid derivative products for virtually all purposes. You have stock index futures like the Dow (YM), S&P 500 (ES) & Nasdaq (NQ) Futures, commodity futures like Crude Oil (CL) and Gold (GC), currency futures like the Euro, Australian Dollar & Canadian Dollar, single stock futures and many more. There was even talk of having futures for Random Access Memory (RAM) chips in order for memory manufacturers and computer hardware manufacturers to hedge their costs.

Understanding the Speculator’s Role

So with all this choice available, how can a newbie or intermediate level trader choose a futures contract to swing or daytrade? Before we get into specifics, there is one thing that you as a speculator must absolutely understand. You must understand that when you earn handsome trading profits, you are in actual fact getting paid for taking risks which someone else did not want during the period of the swing or day trade! If you understand this, then your actions as a speculator will be consistent with that of a service provider who takes on calculated risks and not of a “leech” that tries to profit from other people’s misfortunes. If you approach trading/speculating from this angle, rest assured that your journey to becoming a successful trader from a complete newcomer will be smooth.

Lets now get into some specifics on what you must consider when choosing a contract for swing or day trading futures.

Contract Liquidity

What is liquidity? Lets answer this with an example. If lets say you buy 100 “widget” futures contracts from the futures pit and now when the time comes for you to sell them, you cannot find ready buyers for 100 contracts at the current price but manage to find buyers for only 5 contracts. The only possible way then for you to dispose of your 100 contracts is by selling down to, lets say, 20 ticks below the prevailing price. In this case, this contract is not liquid enough for the size you are trading as you suffer a huge slippage when trying to “square off” your position. If however you only trade 1 or 2 contracts, then the contract may be liquid enough for your needs as your trades are done at or near the prevailing price.

A good indicator of liquidity is to see how much slippage you incur when your “Market Stop Order” for the number of contracts that you normally trade is triggered. If your slippage is huge, then you should consider trading a more liquid contract. The E-mini S&P 500 futures contract (symbol: ES) traded on GLOBEX is an excellent example of a very liquid futures contract. The active front months trade an average of about 1.5 – 2 million contracts a day and there is hardly any slippage even on a few hundred contracts!

Institutional Participation

If you refer back to the article Hedging using Stock Index Futures, you will appreciate why participation by big financial institutions and money managers is important. Essentially it all boils down to these institutions buying insurance to protect their portfolio against any unexpected events that may cause the market to go against their position. If the unexpected event does not occur, these institutions will remove their hedges at a loss, which is their cost of the “insurance policy”. The speculators who took the opposite position would have then profited from this trade as they would be paid for their services of taking risks on behalf of the institutions.

If on the other hand, you have a market full of professional traders and market makers who specialize in nothing but creating a two-way market, without substantial institutional participation, then the new or inexperienced trader will continually have to ask “Who is the Sucker or BagHolder?” As the popular poker saying goes, “If you are wondering who the sucker is, it is probably you!”

Continue to Part 2.