A Short List of Candidates

You can’t trade everything. Well, at least you can’t trade everything well. At some point, you should limit the universe of things you trade. And it’s okay. You don’t need to trade everything because quite frankly, nobody knows what you’re talking about anyway at the weekend cocktail party, and they don’t care. I implore you to be prudent in this way: commit to trading a specific world of underlyings, and quit chasing bright lights in the depths of the ocean, like everyone’s favorite Nemo character, Dory the Blue Tang.

It can be anything such as large cap stocks, penny stocks, major currency pairs, or just one stock or currency pair. Or just the ES futures. Or you can make the case of trading what is cool and in vogue, such as GOOG into earnings, or gold stocks when everyone is buzzing about gold. I’ve chosen to trade the universe of liquid futures. And I’ve wittled down the list of qualifying candidates to just fifty-two.

My list is crafted carefully around major market groups, which have a tendency to inter-relate and correlate. The basic groups include:

1. Currencies (7)
2. Interest Rates (10)
3. Equities (9)
4. Metals (5)
5. Energy (4)
6. Commodities (17)

Currencies:

This group includes the Dollar, Euro, Pound, Yen, Aussie, Swiss Franc and Canadian Dollar. Pretty much the major currencies with the Aussie and Canadian related to commodities.

Interest Rates:

This groups consists of US Treasuries (2-year, 5-year, 10-year, 30-year), the Eurodollar and foreign treasuries that include the Canadian 10-year, the Gilt Long Bond (British debt), and the German debt complex of Eurobund (10-year), Euro BOBL (5-year) and Euro Shatz (2-year). Potential inter-market relationships between these markets and both the currency and equity markets abound.

Equities:

Okay, the standard US equity markets need to be included. I’ve chosen to leave out the DOW futures and focus on the S&P 500, Nasdaq 100 and the Russell 2000. For international exposure I’ve included the Nikkei (Japan), CAC 40 (France), Euro STOXX 50 (Europe), FTSE 100 (Britain), DAX 30(Germany) and the Heng Seng (Hong Kong).

Metals:

You can’t leave out gold or silver. Their ratio is actually an important metric. I’ve also included other precious metals such as platinum and palladium (think catalytic converters and cell phones), and the base metal of copper.

Energy:

Of course we include crude oil and natural gas. Also included are refined products such as heating oil and gasoline.

Commodities:

This is the largest group, so let’s divide it up into Grains, Livestock, Forest and Softs (I’m following the CME Group convention here).

Grains include corn, wheat, soybean, soybean oil, soybean meal, oats and rough rice.

Livestock includes live cattle, lean hogs, feeder cattle and everyone’s favorite future – pork bellies.

Forest includes lumber.

Softs include cocoa, coffee, cotton, sugar and orange juice.

And that’s it.

Just 52 underlyings, many of which have interesting inter-market relationships.

This is my final roster of players, and they will all participate in future backtesting regimes. Will I trade them all? No. Money management may limit the total number of underlyings to a small percentage of the universe, but those 5-7 futures will represent a good diversification of product, and will also be the best representative for a particular trading strategy.

Dory got confused once in Finding Nemo and said: ‘I don’t know where I am… I don’t know what’s going on. I think I lost somebody but I, I can’t remember.’ Don’t be that fish.

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2 Responses to “A Short List of Candidates”

  1. Jez Liberty Says:

    Nice selection you've got there!
    I am surprised as to why you say that money management might dictate a much lower number of instruments. Intuitively a wider universe should ensure a broader diversification (taking into account correlations obviously). Big CTA funds (John Henry, Dave Harding, etc.) tend to trade 50 to 100 types of instruments.
    I think the only limiting factor (but a big one!) is the margin requirement vs. capital available to trade (ie this is one downside of futures – even 1 contract can mean a rather large position and therefore to be able to trade ).

    So if you think that trading a large instrument universe can improve your performance, it is true that having a large account can give you an advantage – that point is examplified here: http://www.traderstech.net/site/pages/The%20Small%20Account%20Conundrum%20RTS.pdf

    I also think that using a large universe for back-test and choosing the best performing instruments for trading might be a form of "data snooping" (that's one of the reasons why I am actually reluctant at actually getting lots of back-tests as I feel that even unconsciously they will give me data snooping insights/biases – before I actually decide on an overall robust research/testing approach – I know it's one of my pitfalls though: I try to conceptualize too much!)

  2. Milk Trader Says:

    Yes the danger of data snooping is in the back of my mind. But I'm confident that a walk-forward is a good insurance policy against that. Cherry picking markets that suit your system best is just the way it is.

    And you're right about margin being the limiting factor as to how many of these instruments can be traded. I haven't done it yet, but if you run all 52 under a system and scroll down to Max DD (or account sized required), you're going to get a pretty big number.

    The choice then is to either take some signals and not others, or to limit the number of underlyings and take every signal. I'm betting that your backtest, optimization and walk-forward (BOW) profile reports will not be wasted time if you choose only specific markets to trade and take every signal, just like the computer did during the BOW.

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