The two most important characteristics for profitable day trading are liquidity and volatility. Liquidity is the extent to which transactions can be quickly and easily executed. Liquidity is the lubricant, but volatility is the engine that drives the profit machine.
For the kinds of markets (stocks, futures, options) under discussion, one of the biggest determinants of liquidity is trading volume - that is, the number of trades, or contracts traded, per unit of time. Markets more actively traded are more liquid than those infrequently traded. It must be understood that liquidity is not an invariant characteristic of a market; it varies from day to day, month to month, and year to year. During the fever of the late 1970s, gold was a very dynamic, liquid market. In the 1980s, gold lost its luster and liquidity declined. In contrast, the S&P 500 has become one of the most liquid markets, fueled by a frenzy of stock and index trading.
Without volatility it is hard to make a profit. And, the shorter the time frame being traded, the greater the volatility necessary if there is to be any chance of success. Volatility is essential to the day trader. Price must gyrate sufficiently within the day to allow profitable trades to be made.
There is an interesting relationship between volatility and liquidity. A market that is highly volatile but not equally liquid can be dangerous. In such a market, a trade can quickly turn sour, while the trader struggles, unable to exit the position. This can happen with futures that lock limit (when trading is temporarily halted by the exchange because of excessive volatility). Before trading a highly volatile market, check to see that the market is also adequately liquid and not prone to limit moves or fast market conditions. Ideally, if the something goes wrong, the trader should be able to exit quickly at the click of a mouse, and thereby limit the potential damage.
Liquidity and volatility are two essential characteristics of instruments suitable for day trading. Day traders must focus on markets that are highly liquid and at least moderately volatile. Balance the liquidity so that it is sufficient, given the volatility, to permit getting out with an acceptable loss, rather than a devastating one, should a trade turn bad.
