Properly "spreading" with real spreads.

[Maverick74]

Mav, I hear what you’re saying about particular aspects of the energy space. I spend a lot of effort with clients talking about the volatility risks associated with refined distillates, precious metals, Cotton, and a few other examples. Also, IMO in terms of intra market spreads generally speaking there’s more volatility risk and delta directionality associated with a calendar pair versus a butterfly or condor.

And in terms of risk - Generally speaking it goes without saying that trading those markets both of us mentioned outright flat price would carry more risk than other products.

In terms of risk management using exchange spreads and a stop limit order with some reasonable slippage seems to work for a stop-loss.

But no, I don’t think a newbie would last very long with a $10 K retail account trading outright RB Gasoline or the RB Crack Spread for that matter.

Speaking for how I handle my own clients - I encourage a discussion with them before they start to trade live. And depending on their capitalization I will suggest product limitations and position sizing. Quite frankly for newbies I suggest they ignore about half the energy complex, precious metals, Cotton, and a few other products. It does me no good at all to see clients get blown out. I like to see clients start out strolling - not sprinting. I encourage clients to grind out income and build account equity. For the most part we’re trading boring markets.

I know what volatility is - I’ve traded heat rates and real time power in July and August; winter and spring Nat Gas Swaps; FERC transmission.

I’m a firm believer in grinding out income in boring markets that you can lever. And in everything there is calculated risk.

So here is what I would say regarding trading flat price vs spreads. I think in a way for complete newbies, flat price is easier in the sense that they "see" the risk. This forces them to trade smaller and also not to be shocked by it. For example, say they traded CL. They could look at a weekly range and see it's about 3 dollars and say OK, if I get short this thing here, I should expect to take about 3 pts of heat on a swing trade. It shouldn't surprise them. If they short a calendar spread and apply the same logic, they might say ok, the avg weekly ranges for this calendar is about 10 ticks so I should expect that much heat and they size accordingly. Then some "fundamental" news comes out that doesn't move flat price that much but blows out the calendar for 100 ticks. Now you and I would probably be aware of this but it's a common trap for a newbie.

In general, all traders I think should move towards spreads as they become better traders. My belief behind this is that if one really has an edge in something, anything, then capturing that edge becomes a lot easier when you can constrain the noise variance from flat price. This is one of the reasons why relative value is such a big hedge fund strategy whether you are a long/short equity fund that is trying to strip out the overall movement of the S&P 500 or you are an options trader who wants to take a vol position while stripping out the directional movement of the underlying or taking a position on the yield curve where you want to be agnostic to the absolute direction of rates and focus more on the shape of the curve.

Everyone should be moving towards that goal in my opinion. However, that comes with time and skill and experience. I think Overnight is a good example of someone who tried to move from flat price trading of CL into weird spread configurations without the requisite knowledge of what he was trying to do. I noticed on a few older threads he started regarding oil I tried to have this dialogue with him regarding some basic fundamentals of oil that he seemed to have backwards. For those of you reading this thread for learning purposes the reason we trade spreads over direction is because it allows one to explicitly express their views on fundamentals. Flat price does a terrible job of capturing fundamental movements in commodities. In my opinion I think flat price is probably read better with charts and momentum type studies while spreads tend to respond to real fundamental concerns. And yes Bone, you are correct in that price has those fundamental views embedded in the chart. However the idea is to understand why the market is pricing the fundamentals the way they are not to simply just accept it. This allows one in my opinion to better trade against them if you disagree.

 

[bone]

I think Overnight is a good example of someone who tried to move from flat price trading of CL into weird spread configurations without the requisite knowledge of what he was trying to do.

No doubt about it. Well said.

 

[bone]

In general, all traders I think should move towards spreads as they become better traders. My belief behind this is that if one really has an edge in something, anything, then capturing that edge becomes a lot easier when you can constrain the noise variance from flat price.

You are making fantastic points, Mav, as usual. And for the record in terms of the clients I take on, I insist that they have trading experience. I also get some feedback from the references those clients interact with as part of their due diligence - from time-to-time, I won't take on a client because the references don't feel like their background is sufficient.

 

[tonysoprano]

Let me talk for a minute about "platforms". Newbies obsess way too much about platforms. I used CQG for 16 years straight and was shamed by clients into using something cheaper. I was also spending about $250 per month on business broadband $800 per month on CQG charting along with $1800 per month for a TT Pro license. For me it was akin to leasing a FULL seat six of one half dozen of the other.

eSignal sucks. I really dislike it. But I use it because it charts ALL of the exchange spreads (literally thousands of them) - and because it makes no sense for a client to spend several thousand dollars needlessly on real time data and for questionable functionality while they are training with me. Since we emphasize spread construction and modeling - we don't even get live data. If you want live data you can look at your execution platform or call your FCM's execution desk. We're swing trading so for us it's not an absolute must.

My point is this: learn the whys and hows before you obsess about executing the trade.

Hello Bone,
You said "eSignal sucks. I really dislike it.". Would you lease elaborate on this a bit. What do you wish it would do that it doesn't and/or what does it currently do that sucks. Have not used it myself but their ability to chart exchange-traded spreads makes it of interest. Thanks

 

[bone]

Hello Bone,
You said "eSignal sucks. I really dislike it.". Would you lease elaborate on this a bit. What do you wish it would do that it doesn't and/or what does it currently do that sucks. Have not used it myself but their ability to chart exchange-traded spreads makes it of interest. Thanks

It's unwieldy. The market scanning and monitoring function does not allow for much customization in terms of indicator packages and even more specifically custom user defined indicator packages. Building custom user defined studies is clumsy and needlessly burdensome - early '90's technology. It doesn't collect and collate data files for export very well. I would be much better off with CQG - and if someone else was paying for it, a Bloomberg terminal. Bloomberg time and sales data is the best in the business. There's a reason why top shelf trading tools like MatLab and S-Plus have toolboxes for a Bloomberg interface.

But eSignal is cheap. And it has all the exchange supported spreads. And the big reason of course is that I got shamed into using it by my clients - the monthly CQG lease fee is pretty steep. And as part of my course materials, I've engineered some quick and dirty workarounds for volatility, hedge ratios, correlations, and such.

And I trade spreads off of price data. And I teach my clients to do the same. And we set our profit targets and stop-loss levels at the time of trade entry - these specifically would be electronic GTC stop-limit orders with slippage on exchange spreads. I have some difference of opinion with Mav on this particular point but we've known each other for a long time now, I completely respect him and I would venture to say that we agree on 95% of trading related topics.

 

[tonysoprano]

In my opinion I think flat price is probably read better with charts and momentum type studies while spreads tend to respond to real fundamental concerns. And yes Bone, you are correct in that price has those fundamental views embedded in the chart.

It just an anecdote, nothing scientific, but reviewing daily charts of a couple of markets such as CL and NG I'd agree that flat price is more amenable to charts and momentum. Spreads seem to have much more noise. I'd bet that if you were to measure the volatility of flat price vs some representative spread (if there is such a thing) that in general the volatility and frequency of vol spikes would be larger with a spread ... in general.

 

[Maverick74]

It just an anecdote, nothing scientific, but reviewing daily charts of a couple of markets such as CL and NG I'd agree that flat price is more amenable to charts and momentum. Spreads seem to have much more noise. I'd bet that if you were to measure the volatility of flat price vs some representative spread (if there is such a thing) that in general the volatility and frequency of vol spikes would be larger with a spread ... in general.

I would say vol is higher with flat price but the relative shocks are greater with spreads. Of course that is where the opportunity is.

 

[bone]

Spreads seem to have much more noise. I'd bet that if you were to measure the volatility of flat price vs some representative spread (if there is such a thing) that in general the volatility and frequency of vol spikes would be larger with a spread ... in general.

If you’re saying that, to use your example, flat price outright CL or NG is less volatile than let’s say a CL or NG butterfly or condor intra market spread that’s just plain wrong on the face of it. Even more so when you get away from the prompt months. Comparing the SPAN margin requirements there is a huge difference. SPAN is going to be much more valid in terms of vol than your anecdotal Mark IV eyeball.

Only possible exception might be an intermarket distillate Crack Spread like RB-CL. Occasionally. I have seen from time to time a Crack Spread have a larger trading range than either of the component products - but it’s rare. Quite frankly my clients seldom dabble with the Crack spreads, as the intra markets fit most clients risk tolerance much better.

 

[kellys]

It just an anecdote, nothing scientific, but reviewing daily charts of a couple of markets such as CL and NG I'd agree that flat price is more amenable to charts and momentum. Spreads seem to have much more noise. I'd bet that if you were to measure the volatility of flat price vs some representative spread (if there is such a thing) that in general the volatility and frequency of vol spikes would be larger with a spread ... in general.

@tonysoprano

This is just my personal observation only, but I find spreads tend to behave better in their movement.
I have attached two charts (over the week):
NOB
ZNH18
What is notable is the 'randomness' of the outright in combination with irregular volatility.
The spread is very measured in the way it moves.
I like that about spreads. Once they get rolling they stay rolling.
Consistency and reliability, mostly.

 

[bone]

@tonysoprano

This is just my personal observation only, but I find spreads tend to behave better in their movement.

And that is what all my clients tell me - and mind you, these are experienced traders who have usually traded something like ES or CL or ZC or ZB outright flat price for years before they hired me and came to find out what a proper Spread truly is.