Know the Futures Market Volatility and Accept the Consequences
You often hear futures traders talk about their need for volatility. It is a common perception among the trading community that higher volatility is equivalent to higher opportunity, and therefore profit potential. Call me a "girl", but I happen to be a contrarian when it comes to this point of view. Sure, if the markets are moving there is an increased chance for you to catch a large move and make history in your trading account. However, there is another side to the story; let's not forget that if the market goes against your futures trade you could be put in an agonizing position. Also, if you are a trader that insists on using stop loss orders, increased levels of futures market volatility translates into amplified odds of being stopped out prematurely.
I am not suggesting that you avoid the futures markets during times of explosive trade; however, you must fully understand the consequences and be willing to accept the inflated risk of trading accordingly.
In my opinion, the most convenient way of measuring commodity market volatility is through the use of Bollinger Bands. The bands allow a trader to visualize the explosion and contraction of market volatility with similar movements in the bands. Simply put, as the Bollinger bands get wider, the volatility and market risk is also on the rise. Conversely, tighter Bollinger bands suggest relatively lower levels of volatility. Please note that I didn't say lower levels of day trading risk; this was intentional.
Figure 1: E-mini S&P 500 Futures - Traders can visualize futures market volatility through the use of Bollinger Bands. It is a good idea to do so on a daily chart to get the big picture of market volatility.
Narrow bands indicate that futures market volatility is relatively low, but if the contraction is excessive enough it may signal an extraordinary spike in price is imminent. Markets go through times of quiet trade, but such times are often followed by large and sudden increases in instability. As you can imagine, being in the futures market at such times could be similar to winning the lottery or they could mean financial peril. Before executing a futures day trade in a fast moving market, or one that is trading quietly, you must be aware of market tendencies to properly assess the risk of initiating a futures day trade. Being conscious of all of the potential outcomes of your futures day trade may prevent panic liquidation or the infamous deer in the headlights failure to act.
Commodity Trader's Tool Box
Technology has provided traders with an abundance of readily available information at their fingertips. Accordingly, I strongly believe that traders should properly understand and utilize the resources available to them. It doesn't make sense to pick a single indicator or oscillator and expect it to tell you the whole story; instead it should be viewed as a piece to the puzzle. With that said, it can often be counterproductive to bog yourself down with too much information or guidance; this is often referred to as analysis paralysis.
In my opinion, it is a good idea to pick three or four tools that fit your needs and personality. For example, if you are an aggressive trader with a high tolerance for risk you may opt for a quick oscillator such as the Fast Stochastics. If you are a slower paced individual, the MACD may better suit your needs as it is a much slower moving indication of trend reversals.
It is important to note that after you have entered a trade you shouldn't change the oscillator that you are watching simply because the original isn't telling you what you want to hear, or in this case see. This can be a tempting practice for traders that are caught in an adversely moving market and are in search of a reason to stay in the trade for fear of taking a loss.