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Typically the higher the liquidity for the chosen market, the lower the cost of entry (i.e., less slippage). Treasury bonds, for example, have a very negligible cost of execution, whereas platinum can be very expensive. A speculator thrives on liquidity as a way to control risk, and is hurt by avoidable risk. |
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2. Monitoring the volatility of a market. Whenever the volatility changes, trading leverage should be adjusted accordingly. As the volatility increases the likelihood of an adverse price movement increases; therefore, the number of contracts should be reduced. Likewise, as the volatility diminishes, the possibility of an adverse price movement diminishes and the leverage factor can be adjusted upward. This rule is of great benefit if adhered to. The reason is that whenever the continuity of thought changes, many large emotional mood swings will be reflected in the price. Therefore when the leverage, or number of contracts traded, is reduced, the number of contracts held at a market turn will be reduced as volatility increases. The volatility of a market is related to some degree to liquidity and the bid/ask spread. |
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The bid/ask spread is an indication of market liquidity. As the spread loosens, the amount of money lost upon entering or exiting the trade will also increase. In other words it is a market commission for entering and exiting a trade. As the liquidity of a market increases, the bid/ask spread becomes tighter. By contrast, an illiquid market will have a wide bid/ask spread. Another way to see the bid/ask spread risk is as an approximate indication of the number of participants. An interesting aspect of a market that is locked limit up or down is that typically the bid/ask spread will narrow in the front and back month. This is because, in a lock limit move, you are still allowed to trade spreads. Typically a trader will execute a spread then break a leg in order to exit a lock limit market. |
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Reducing the Risk of a Series of Losses |
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Another practice that many outstanding traders implement when they start having a losing streak is to reduce the number of contracts traded until the losing streak breaks. By reducing their exposure to the market, they are able to prevent a losing streak from becoming a major retracement of their equity. Generally they know that the losing streak has ended when the red ink fades and black ink is consistently appearing. |
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The important thing to remember is that you should not get into a position where your trading equity is overcommitted, so that a series of bad trades could consume your equity and halt your trading efforts. |
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