CME - Why Smart Money Trades Spreads

[MrMuppet]

Truth be told, though I traded basically everything with every possible style, I found most success with relative value trading which spreads are more or less a subset of.

Spread trading rewards proficiency and knowledge in a certain market and knowing it's fundamentals. Knowing where basis should trade or how a spread moves as proxy to spot is a huge edge also for trading outrights.

Of course you can go the correlation/cointegration/z-score route and construct your ratios with statistics, but that is not for me.

Almost all profitable traders I know are spreaders. STIRs, grains, FX, crypto. I've never met anyone who traded size outright...but that's also just me. Knowing how to weasel out of a bad trade by spreading it off into a position that has time decay or convexity is probably the best way to manage risk.



It has nothing to do with "trading" in the ET sense, but that's exactly why I love this book:

https://www.elainekub.com/masteringthegrainmarkets

Everyone who is interested in learning how the commercials trade, should read it before even opening a chart.

 

[heispark]

There was a very sustained {huge} Contango move in the CL forward curve for several weeks before the May expiry. Point being - you would have been crushed long before April 21st if you were long May or the prompt month against anything.

If I had bet on spread widening, I would have made huge money... I guess betting on spread widening rather than narrowing is safer....

 

[maxinger]

CME - Why Smart people Trades Spreads

 

[heispark]

Spread trading is fun. It's important to note I've found generally that trading further back month spreads is more profitable. The only reason I survived the oil plunge was I was way out on the curve.

I focus mainly on seasonality. It's been fairly profitable to me, and after losing a chunk of my account to the oil dips (I still lost I just didn't get destroyed) I am slowly but surely pulling myself out of the hole again. I probably won't trade oil again for a while though. The trick really is to have good data and historical research. Without it, spread trading is basically just margin reducing an outright position. I generally sit on my position for months (currently I'm in a natural gas spread that I'll take off some time in late July). It's not really for the spastic daytrader.

However, when you trade further back month spreads, you may experience wider spread+slippage.... Am I correct?
The following is /NG June+July spread chart and even it doesn't look liquid enough.

 

[heispark]

I am new to spread trading and started testing with real money from this month. Less than two weeks, I easily made 10% profit although my account size is very small. I traded total 3 times (2 pairs each). As my broker AMP doesn't support exchange supported spread trading, I manually bought/sold /NG June+July contracts. Although AMP doesn't provide margin reduction at all (it might be negotiable, they said to me they will discuss this with Rithmic), it's not a big concern to me (actually, I am a big believer that low leverage is always good.) I don't want to make things overly complicated. I want to focus on very simple current/next month spread combo. If I am correct, betting on spread widening is safer than spread narrowing. Although current market is somewhat nervous, when market is calm, spread trading looks consistently profitable with lower risk.....

 

[R1234]

what i found great about spreads compared to naked futs is spreads trade in channels very often which helps really... there are some very nice S/R levels in many spreads that can be used year after year

Do you primarily do counter-trend trading betting on reversals into a channel? I have found that effect to be strong in intermarket spreads such as corn/wheat, soybean/soybean oil, etc. But not so much in the intramarket calendar spreads such as corn/corn, wheat/wheat etc - there I tend to see more divergence continuation opportunities.

 

[bone]

I’m very skeptical about your data.

However, when you trade further back month spreads, you may experience wider spread+slippage.... Am I correct?
The following is /NG June+July spread chart and even it doesn't look liquid enough.

 

[bone]

Fortunately you’re flat out wrong about spread trading small accounts. And btw, I’ve seen energy Crack Spreads and precious metal spreads move over $1K per day in trading range on a one lot spread.

spread traders provide the liquidity to speculators. and act as market makers
for small size accounts, spread trading the reward is too low for the time and work doing the trade.
your account size or capital needs to be large to make it worth the capital as returns are lower if you spread trade. that is why some traders don't bother with spread trading.

Also some contracts are too illiquid to trade especially the options in futures
there is no bid or ask in the options.

 

[JigsawTrading]

Good primer from the CME on spread trading futures. footnote: I am personally not a big fan of spreading WTI versus Brent - the positive correlation has come way off the past several years and the cointegration tendencies have gone up (not good). But for the most part these are good, solid introductory concepts.

The intra market complex spreads [for example, CL Dec 20-Mar21-Jun21, 1-2-1 Butterfly] {NG Jan21-Feb21-Mar21-Apr21 Condor} are the types of trade constructs where my own clients spend most of their time.

I have found that the CME Education Section has some of the best publicly available materials I have personally seen on spread trading. And it's free.

https://www.cmegroup.com/education/articles-and-reports/why-smart-money-trades-spreads-part-i.html

https://www.cmegroup.com/education/articles-and-reports/why-smart-money-trades-spreads-part-ii.html

https://www.cmegroup.com/education/articles-and-reports/why-smart-money-trades-spreads-part-iii.html

https://www.cmegroup.com/education/articles-and-reports/why-smart-money-trades-spreads-part-iv.html

Interesting - but don't you feel the CME's vested interest is in the extra commissions? Or are you trading exchange-traded spreads?

I recently witnessed the rise and fall of a prop firm. Don't want to say who/where - but spreads was the game and what struck me during the setup phase was the firms focus on generating fees.

The firm could make money overall without the traders making money. A lot of guys were squeezing a living despite commissions and a number were seeing commissions wipe them out.

This was all interest rates at a time that interest rates were at historical lows. For some reason, they stuck with the same markets and a lot of firms (including this startup) didn't survive.

So - I'd be interested to hear how the trader at home would
- get over the commission hurdle
- decide when a particular market had run its course from a spread-perspective and find better markets

It's not my arena - but I am always interested to hear from people on a different side of the game. Not quite ready to take CME's word on it, though - but I do think the retail side needs to hear more about spreading than always be obsessed with outrights.

 

[JigsawTrading]

spread traders provide the liquidity to speculators. and act as market makers
for small size accounts, spread trading the reward is too low for the time and work doing the trade.
your account size or capital needs to be large to make it worth the capital as returns are lower if you spread trade. that is why some traders don't bother with spread trading.

Also some contracts are too illiquid to trade especially the options in futures
there is no bid or ask in the options.

Spread traders do provide liquidity - but they also need an active market with people willing to give up the spread. Liquidity shifts around over time. Hence my last question to the OP on locating it.

As for account size - I'm not sure why it is important. Most people can't make money trading 1 lot on outrights. I think people should get over that hurdle first.