Why you need to use Continuous contract - Volume Based, Back adjusted

Why you need to use Continuous contract - Volume Based, Back adjusted

A continuous contract, volume-based, back-adjusted, is a type of price representation where each futures contract are "stitch" together to show a seamless representation of price action. To better understand it let's break down each aspect:

Continuous Contract

In futures trading, contracts have expiration dates. When one contract expires, traders typically roll over their positions to the next contract to maintain exposure to the market. For example the S&P500 is a quarterly contract, each month is represented by a different letter (March = H, June = M, September = U and December = Z). A continuous contract combines the price data of multiple individual contracts into one continuous series, effectively stitching together the price data from each contract to create a long-term price history without gaps.

 

Volume-Based

 

 

This means that when stitching together the price data of individual contracts, the rollover (changing the contract that you trade) is based on its trading volume and not the actual rollover date. You should always prioritize the contract with the most volume to ensure the fill of your trades. Trading in an environment with poor liquidity will induce slippage (fill at a worse price) and important spread (gap between Bid and Ask). 

 

 

Back-Adjusted

Futures contracts are subject to price distortions, I remind you that each are individual contract with different expiration. Back-adjustment is a method used to eliminate these distortions by adjusting historical prices of each contract to the subsequent contract prices. This adjustment effectively removes the influence of the contract rollover from the historical price series, allowing for a more accurate representation of price movements over time.   

    Price difference between contracts 
    The gap between contracts don't actually exist, this gap is only due to the difference between contracts. So if you use a continuous contract without back adjustment it can mess up the position of the volume (as seen below). Again, as you can see in the third picture ESM4 contract alone don't have any gap, this gap is only due to the difference between ESH4 and ESM4 contracts.

         

        In summary, a continuous contract, volume-based, back-adjusted, provides traders with a seamless and accurate representation of price movements in a futures market over time, by combining the price data of multiple individual contracts, weighting them based on trading volume, and adjusting for distortions caused by contract rollovers. This type of contract is particularly useful for analyzing long-term trends and making informed trading decisions with accurate volume position.

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