Designing a portfolio to trade could be one of the most important decisions in designing a futures trading system. If you add the wrong contract it could mean a nasty drawdown or more volatile returns. Most system developers spend little time on the portfolio selection process and concentrate on developing the day trading system. Before you begin live trading consider these four points when selecting new components of your trading system.
Liquidity is the first component. Liquidity is a measure of the volume and depth of a market. The more liquid a market the better. Liquid markets have tighter spreads for entry and exit. Tighter markets translate into savings on slippage. Too much slippage on every trade can wreck your return quickly. In addition, illiquid markets can be hectic during volatile periods. Getting out during volatile times in an illiquid market will be very costly.
Commission costs are the second component.
Do everything that you can to lower these costs. If that means shopping around then do it. These are your fixed cost on every trade. Every penny that you save goes right to your bottom line.Volatility is the third component. Your bet size per trade should have a volatility adjustment. Each individual contract will have fluctuating volatility. During volatile times it is prudent to lower your bet size. An ten day average true range is a good indicator of volatility.
Correlation is the final component. Each contract will have a relationship with the other contracts in your portfolio. Find contracts that move in opposite directions at the same time. This will lower your variability of return. If you can earn the same return with less variation then your portfolio will outperform.
4 Ways To Choose The Right Markets For Your Futures Trading Sysytem