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Asset Rules

The title of this section should actually be: "Carefully Choosing the trading Asset", because it is one of the key things which will determine the what, how, when, why and whether algotrading will be a long-term activity or something short lived.

Even if it may seem counter-intuitive, the asset (or asset type) has to be chosen before the house is chosen and that is because not all houses offer all assets. There are houses (brokers) which do, for example, specialize in futures and will not offer stock trading.

Properties

Strictly speaking, the asset rules are actually the properties which define the asset, such as: trading times, exchanges, brokers, margin, multiplier, trading currency.

The most important property/rule is what will actually determine the asset suitability and whether it should be chosen: its behavior.

One can assume that an algorithm that proves to be profitable for a given time series, will also be profitable for other time series, i.e.: for other assets. And most often than not this will be proven wrong. The reason being: the participants for each asset (or asset type)., be it humans or machines, are different. And this "difference" conforms the trading nature of the asset.

For example: when an asset finds itself in a trend, some will move smoothly along a hypothetical curve in the direction of the trend. No whipsawing. And other assets may have the same starting and ending points for this hypothetical curve, but will have sudden and violent moves, volatility, around the curve, which will whipsaw the position and make most algorithms and humans bail out sooner rather than later.

Both assets yield the same returns, but a single strategy may succeed in capturing the trend of the former and be stopped out several times with the latter, which will end up resulting in a loss.

The morale here is: study the asset, its properties and its nature to understand if the asset is actually fit to be chosen as an objective.

Let us see some of the most common asset types and the characteristics

Asset Classes

Stocks

Everybody's friend, because it is in the vocabulary of every family and they are offered by the cashier behind the glass when visiting the bank. Usual traits:

  • Central Authority: Yes. Although the same stock can be traded in different exchanges and even in different currencies and also in dark pool, for a retail trader things are regulated, hence the "Yes"

  • Price Tracking: the ticks correspond the last executed buy/sell in the market

  • Trading times: 8/5 with something like 09:00-17:00 (mileage may vary)

    These are regular trading times. Depending on the exchange and broker, there may be access to extended trading times.

  • Trading calendar: mostly matches the typical working calendar of a person

  • Long / Short: Regular people can only go long. Yes, it is possible to short stocks but this requires access to special facilities. From a practical point of view: only long

  • Leverage / Multiplier: None. WYBIWYG (What You Buy Is What You Get)

  • Margin: None. You can buy what you have.

  • Expiration: unless the company goes out of business or decides to remove itself from the market, your stocks will not expire.

  • Commissions: a very wide ecosystem, with %-based commission with and without cap, flat-rates, maintenance, stamp duty, finance-taxes (Tobin), etc. The final commission will have country-based factors, exchange-based factors and broker-based factors.

Futures

Feared by many, loved by many others. You buy/sell something and when the price goes in your favor, profit is immediate and multiplied by a factor. Losses happen in the opposite direction and are also multiplied.

Everybody's friend, because it is in the vocabulary of every family and they are offered by the cashier behind the glass when visiting the bank. Usual traits:

  • Central Authority: Yes. Futures are regulated and offered through specific exchanges.

  • Price Tracking: the ticks correspond the last executed buy/sell in the market

  • Trading times: the current trend for the most liquid assets is almost24x5. You can count here the ES-Mini (S&P 500 mini futures) and the FESX (Eurostoxx 50 Future)

    For other not-so-liquid futures, trading times may look like this: 08:00-20:00 or simply match the trading times of stocks in the exchange.

  • Trading calendar: weekends are free, but many bank holidays tend to be trading days and the weekend can end early as it happens with the ES-Mini

  • Long / Short: Both. As easy as deciding in which direction you want to trade.

  • Leverage / Multiplier: A multiplier is used. For example 10 x Point for the Eurostoxx50, 50 x Point for the ES-Mini (or 12.5 x 0.25 Points which is the smallest tick)

    No, the multiplier is not leverage. It multiplies how much you win or you lose when calculating your P&L with regards to your entry position.

  • Margin:

    The amount of cash per future needed in the account to back a position.

    • Intraday: Somewhere between 15%-25% of the full margin

    • Full Margin (applied overnight): close to the value of the future expressed in the currency in which it operates. I.e.: if the Eurostoxx50 has a closing price of 3000, the actual margin won't be far away from €3000.

    It should be obvious that pure intraday strategies can operate with large numbers of futures which may not fit into the overnight margin. If that's the case and the trader does not liquidate the positions, the broker will do it until the margin for the open position can be backed by the existing cash in the account.

  • Expiration: the most well known futures expire once every 3 months (the 3rd Friday of March, June, September and December), but monthly and other expiration periods do also exist.

    Rolling over during expiration is possible, but the usual entry/exit commissions do apply. Take into account that the price across expirations can have huge gaps, because the price model of a future takes into account the dividends that the underlying asset will distribute (index futures, stock futures)

  • Commissions: From the point of view of the trader almost always a flat fee per future and entry/exit.

    Some discount brokers offer a break down of the price in exchange fees, own fees, ... and will offer volume discounts.

Forex

A favorite of the general public, because currencies are well known (fiat currencies are still a thing even in spite of the crypto hype) and because non-regulated shops offer them with leverage to attract retail traders.

Feared by many, loved by many others. You buy/sell something and when the price goes in your favor, profit is immediate and multiplied by a factor. Losses happen in the opposite direction and are also multiplied.

Everybody's friend, because it is in the vocabulary of every family and they are offered by the cashier behind the glass when visiting the bank. Usual traits:

  • Central Authority: No. Each shop offering forex pairs does it on its own. There is for example no way to have an expectation of the actual total volume traded for a forex pair.

  • Price Tracking: the ticks correspond to ... good question. The prices do not necessarily mean something (a buy/sell exchange) was executed. Example: the Forex prices that Interactive Brokers delivered were the BID price.

    This means that when backtesting a strategy, the trader cannot be sure if buy/sell operation in the backtester, against historical prices, would have actually executed.

    And each shop has its own set of prices and volume.

  • Trading times: 24/5.

  • Trading calendar: weekends are free but trading resumes on Sunday evening.

  • Long / Short: Both. As easy as deciding in which direction you want to trade.

  • Leverage / Multiplier: As opposed to Futures, leverage is used, *which means you can buy a lot more than the cash in your account would allow.

    This also means, of course, that winning/losing can happen a lot faster. Unlike with futures and due to the lack of margin, a lot more can be lost.

  • Margin: No. See above for leverage

  • Expiration: None (even if crypto-rulez says that fiat currencies are already doomed)

  • Commissions: A flat-fee scheme, but because of the nature of the shops, this has to be found out on a per case basis.

Cryptocurrencies

Even with all the hype and the attractive it has for many, due to the volatile nature of how cryptocurrencies move, it is just another asset. It may or may not be right for the trader or the strategy.

  • Central Authority: No. Looking at the Bitcoin, for example, it would seem the Blockchain plays the role of the central authority. But having a ledger which keeps track of the transactions, does not mean that things are regulated and centralized. Prices in the exchanges can vary, the rules are different and regulation is notoriously absent.

  • Price Tracking: You get the execution price from a given exchange. Unlike with forex, this is actual execution, but data sets will vary depending on the source

  • Trading times: 24/7

  • Trading calendar: Always. No free evenings or weekends.

  • Long / Short: Both.

  • Leverage / Multiplier: Futures for cryptocurrencies have already been issued enabling multiplies and some exchanges may offer leverage. Check your exchange.

  • Margin: No

  • Expiration: None, if you exclude that some cryptocurrencies do actually expire (die)

  • Commissions: Very varied, including different prices for different order types (whether you inject liquidity in the market or take it out of the market)