Does the product you trade determine your success?

Markets

Apr 06

We know that picking the right market can influence your success. But, here’s a simpler question, does the product you trade determine your probability of success as a trader?

Let’s take a look at various products and their pros and cons.

The Contenders

Stocks

I have did very little stock trading. However, if you are at a prop firm, I would imagine stocks might offer the highest probability to become profitable.

Why? Because there is a huge universe of stocks and you can find more factors that can drive individual stocks. You can also find both long and short opportunities.

For active retail traders, the picture is far less favorable. You have the “Pattern Day Trading” restrictions, lack of leverage, lack of quality information, and most likely you will be on the wrong side of news on swing trades. So, you have single stock risk.

As such, my feeling is that stocks offer one of the best opportunities for prop traders but aren’t really well-suited to actively trading for retail self-directed traders. Of course, stocks do offer great intermediate and long term reward.

Options

With both stock options and options on futures and with the potential to both day trade, sell premium and swing trade options, I feel that options most-likely provide the retail trader with the highest probability of meaningful trading profit with measured risk and moderate skill.

More over, options on futures are not subject to the “Pattern Day Trading” rule. You can express a wider range of sentiment and are less impacted by HFT algorithmic dominated trade that result in stop loss runs.

In fact, I even think that NADEX one touch, spreads, and binaries offer opportunity for high confidence trades provided they are large enough to overcome the transaction costs.

Many futures traders just want to trade the direction of the day, and so these products are certainly interesting. If you only had access to binaries, I think it would be a disadvantage but when combined with futures, I can see a lot of potential, even though I am not currently trading them. I found the binaries fascinating, something I’d like to try to trade again, but facility of entry was not the best at the time.

While I think options probably provide the best potential to profit, I am skeptical, but undecided, of claims that actually selling options, without a systematic edge or ability to predict markets, offer an actual edge to the retail trader.

Futures

I would consider my background as primarily in futures trading. Futures do offer many benefits.

Unfortunately, if I had to give a realistic and honest assessment for most traders, I think futures offer the second to least chance of success of any product particularly if one has only a tiny account. You find very few professional proprietary and stock trading firms who have traders who primarily trade the futures.

The majority of the trade is algorithmic and the “market cognition”, while similar to years past tends to play out much faster.

Despite the difficulties, the potential to profit more consistently is greater then in options because you do not need as significant a market move to profit from. Automation is considerably easier, as well.

You also have advantage over secondary markets where market maker spreads could eat up all potential profits. For active traders, trading costs are a significant consideration.

Forex

Based on published returns, policy actions, bank actions, and history of violent moves, my feeling is that Forex offers the lowest probability of success of any market and trading product.

However, they can be traded with minimal risk, tend to offer more efficient spreads then secondaries (i.e. on the indices), sometimes trend strongly, and all of this may may be a benefit to the new trader or offer profit potential in exceptional cases. Do you know any professional FX traders? Let me know.

Cryptos

I think for this post, this space, has too many complexities to consider for treatment. I think it suffices that this space offers high risk and high reward potential. As far as products, there are various exchanges and products for expressing sentiment.

The Take Away

Now having shared all that, I am still focusing on futures but feel like options provide me greater versatility to express my market opinions.

I believe the strongest take away is that small traders who focus exclusively on futures are probably decreasing their probability of success and more importantly might be able to create synergistic opportunities once they add in some products like options on futures to the mix.

Because my thesis is that once you add in binaries, options on futures, stock options (possibly), and spreads you have far greater potential to find and structure trades with edge.

As a real-life example, when the Trump investigation conclusions were released the futures market gapped up on the Sunday night open. I anticipated that.

There was a great opportunity to buy a low risk pull back with very limited risk. But, the market eventually sold off hard. As an aside, I lost quite a bit more then I desired on that side of the trade due to an order handling mistake. So, we’re talking about probabilities of risk– things can always go wrong.

To get to the point, the futures offered the highly skilled trader an excellent low risk opportunity to express an opinion which ultimately didn’t work out. The market extended severely to the downside.

Yes, the futures trade offered opportunity and one I would take again. However, after the market extended to the downside then in order to express a similar idea that the market will be higher in a few days then you would need to either try to find another pinpoint precise entry or use a larger stop loss to have ample probability of catching that move. In either case, the question to ask is whether we are talking about some statistical phenomena that can be “captured”. Importantly, getting stopped out would have practically no bearing on whether the market moved much higher the next day. So, there is a high probability you could be stopped out and yet right on your idea.

On the other hand, selling a put spread above the market in the options market was an easy way to express the same idea with completely limited risk. In fact, I mostly broke even overall on the idea due to my options trades– even with the order handling mistake. One disadvantage was that even though I was buying relatively near the lows, the options pricing barely reflected my timing. But, unlike the futures trade, I was able to stick with the trade to capture the full profit.

Of course, I can give a counter example where I correctly predicted a mini-bear attack last week. If I had traded it with ES futures, I might have risked $100 max for 1 contract and pulled out $200 or $250. As it happened, I sold an options spread which had around $100 max risk with $300 profit potential. The market made a fast move down and then bounced right back. My options trade gained maybe $50 in value at the peak and then went negative. I sold it around the break even for a small loss. That was not a trade to take with options on futures. The key thus seems to be able to accurately gauge the ability to capture a profit with limited risk with the various products.

Have you added some of these other products to your futures trading? Let me know how it works for you.

Post Script: I think this is a good treatment. But there is another way to treat the question which is simply to consider the trading costs as the most important factor. In that case, your best bet would probably be to trade a highly liquid ETF stock- like SPY.

The most relevant ranking criteria would need to factor in all of the following: efficiency (tight spreads), liquidity (ability to get in and out), leverage (high leverage is better), granularity (high granularity is better, control risk), risk control (defined vs undefined), opportunity (more markets, greater opportunity), flexibility (ability to structure trades), and trading costs (lower is better).

About the Author

Curtis is passionate about markets. He has developed top ranked futures strategies. His core focus is (1) applying machine learning and developing systematic strategies, and (2) solving the toughest problems of discretionary trading by applying quantitative tools, machine learning, and performance discipline. You can contact him at curtis@beyondbacktesting.com.

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