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some equity with a methodology that performs well in a trending market, and also allocating a percentage with a methodology that performs well in a nontrending market, the trader is reducing risk. |
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Often one methodology will be long in one market, while a different methodology could be long (or short). These different methodologies and markets tend to reduce the amount of risk being experienced. By adding a methodology that has a lower rate of return than their primary methodology, traders can actually increase the overall return! The assumption here is that the markets being traded are not highly correlated, so that the risk reduction gained by diversification of methodologies is greater than the decline in the overall return and the leverage factor is adjusted accordingly! |
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1. Monitoring the liquidity of a market. Traders can reduce risk by carefully monitoring the liquidity of the markets they are trading in. Generally the higher the volume, and the higher the open interest, the more liquid the market is. Stock traders need be concerned only about volume. There is an interesting relationship between liquidity and volatility. As the volatility of a market increases, so does the inherent and unavoidable riskwith an increase of profit potential. However, as the liquidity of a market increases, the inherent and unavoidable risk decreaseswithout affecting the profit potential. Liquidity and volatility are two different animals, and should not be confused. Although a lack of liquidity could be caused by high volatility, a lack of volatility is not caused by a lack of liquidity. Likewise, high volatility is not dependent on a lack of liquidity. |
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The vast majority of commodity traders should examine the volume of trades when ascertaining the level of liquidity, rather than the amount open interest. A market that has a lot of open interest and little volume is typically less liquid than a market with little open interest and lots of volume. In most cases, only the very large traders and commercials hedgers pay a lot of attention to open interest in determining the liquidity of the market. The reason is that they need to know how their trades will affect the market. If the open interest is small, they have to think about who will take the other side of their position upon entering or exiting the trade. The liquidity of a market becomes a self-feeding circlethat is, a market with a lot of liquidity tends to attract even more traders, making it even more liquid. |
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The more liquid contract in a particular market is the contract you need to be trading. If it is currently June, why trade December when the September contract has more volume or liquidity? In most cases December will not have as much liquidity as September. Determining the more liquid month is as easy as opening the newspaper and reading the number of contracts traded. |
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