- Trading in stocks, indices, currencies, commodities, and bonds
- CFDs versus Futures, about Contango and Backwardation
- Trading in Options
- Trading in stocks, indices, currencies, commodities, and bonds
It is common for people that go into day trading to have dabbled in stocks before they make the switch. As liquidity for most stocks traded in Europe is too poor to consider day trading them, private traders tend to focus on the stock indices if they want to stick with trading stocks. A stock index is a weighted average of a pool of stocks. The most known are the major US indices, Dow Jones, S&P, and Nasdaq – in Europe the DAX-40 (Germany) and the FTSE-100 (UK). But there is a well of other indices to choose from.
It is worth keeping an eye on the stocks that make up the index you trade – and also the number of stocks in the index (how much is the effect of the movements of a single stock smoothed out). Those two pieces of information could give you a better understanding of the change in the price of the index and prevent you from overinterpreting the things you see. As an example, when two indices that usually are highly correlated start being out of sync it can’t always be taken as a divergence and thus a trading signal – often it would be because some major stock component in one of the indices made a big move.
One great advantage of using indices for trading is that they tend to be smoother, less volatile, and therefore more “technical” than single stocks.
Currencies
Also known as Forex, currency trading is in fact the biggest and most liquid market in the world. However, many traders find it less suitable for day trading and at Ago-trade we share that view. On the other hand, it can work very well for medium to long-term trading.
Another notable feature about trading currencies is that we are looking at currency pairs, which is simply the exchange rate between two currencies. The one named last is the base currency. So, for EURUSD the price given is the exchange rate for euros as expressed in ÚS dollars.
It is common knowledge that a basic rule applies to the stock market when looked at over a long period of time: Stocks appreciate over time (not necessarily true for single stocks, of course). A similar rule does not exist within currency pairs. In other words, when you are long – or short – a currency pair it is just a reflection of which currency you favour the most at that point in time.
Commodities
These include tangible goods like soybeans, wheat or pork bellies – as well as metals and sources of energy (oil, natural gas). Here the most traded products among day traders are WTI Oil (crude) and Gold, as liquidity in those products is good and volatility is sufficiently high.
Bonds and the crypto market
The most popular instruments for trading bonds are the 10-year Treasury (U.S) and the German Bund (~the 10-year government bond). As margin requirement is quite high for trading these markets, as is the need for extensive macroeconomic knowledge, it is rare to see bonds used in day trading among retail traders.
We don’t cover the field of cryptocurrencies at Ago-trade. As we all should know, it is an unregulated market, with plenty of stories of fortunes vanishing into thin air through hacking, or through brokers going bankrupt. Secondly, it is not very practical for the purpose of day trading as spreads are generally very high.
- CFDs versus Futures, about Contango and Backwardation
In Europe, CFD-trading and spread betting are the vehicles most used in day trading. CFDs are banned in the U.S, therefore day trading is limited to trading stocks and futures in America. CFDs or contracts for difference are derivates provided by brokers that continuously mirror price for the products they are linked to. It is, with a few exceptions, the cash price of the index or commodity in question that we see and follow, not the futures price.
Though virtually 100% correlated, it is essential to know which type of price (cash or future) you trade at a given time, as prices may differ by as much as 100 points or more in the Dow, for instance. A classic mistake is to mistake the two sets of prices, thus proceeding to read the market in the wrong way.
Stock index futures expire 4 times a year (in March, June, September, December). It takes place on the 3rd Friday of that month. It is known as Triple Witching Day – as it also sees the expiry of stock options and stock index options.
The most traded contract – by far – is the one to expire next. As the date of expiry approaches, the futures price will get closer and closer to the cash/spot price. The relation between them is described by the terms contango and backwardation, shown in the chart below:
A market in contango has a price for the future, which is higher than the spot price. Conversely for a market in backwardation. By this definition, the markets we are trading here at Ago-trade are in backwardation. Cash price for that particular future (shown by the horizontal line in the chart) lies above the futures price, which is the curved line below it.
What may be a bit confusing here is that cash price itself will be gyrating over time and in real life never constitute a straight, horizontal line. The main point to take away from this, however, is that the futures price will always be placed below at a pre-defined distance from the cash price. The distance will slowly go down by the day until expiry.
- Options
Options aren’t as popular among retail traders as futures trading and CFDs are. Still, they are worth knowing about and, to be fair, there is quite a large number of traders that use them. Due to the relative high cost of trading them, they are rarely used in day trading, but rather as a hedge of one’s trading account – or alternatively, as independent streams of income based on various long-term option strategies. These strategies frequently hold exotic names, such as covered call, married put, collar, straddle and butterfly.
There are two basic types of options, call options and put options. A call option is a bet that the underlying instrument (stock, index, commodity, etc.) will be above a certain price – the strike price – at a certain time in the future – the expiry date. The reverse for a put option, meaning the buyer of the option hopes to see the price of the underlying below a certain price at expiry.
As suggested by the name, the buyer has the option, not the obligation, to receive the underlying asset at the time of expiry. It is of course only when the option is in-the-money that the owner of that option has any interest in exercising. Another thing worth noting is the difference between American options and European options. American options are generally traded far more, mostly due to the fact that they can be traded at any time, thus you don’t have to wait until it expires to trade it, which is the case for its European counterpart. That lends you a lot more flexibility in creating trading strategies for options.
The premium of an option, aka its price at the time of purchase, reflects the likelihood of the strike price to be reached at expiry. On the other side of the bet is the seller of the option, who collects the premium but at the same time takes on a larger monetary risk than the buyer of said option. They, in turn, would often protect themselves through buying options with strike prices further up/down in order to limit their risk. This will act as a stoploss for their positions. Having said that, the vast majority of options do in fact expire worthless.
The premium you pay to acquire an option at a given time depends on three variables: The price of the underlying instrument, time until expiry (the longer, the more can happen), and the volatility of the underlying. The dependence on volatility in determining the price of the option is where options fundamentally differ from other asset classes.
