Spread Trading - to me at least, is a completely different way of looking at markets. Statistical or fundamental relationships between instruments are the driving influence.
I personally like to use both statistical analysis and a specialized charting technical study in terms of spread trade entry signals. I always set my profit target and my stop-loss level at the time of entry.
If we enter into a hedged position using multiple instruments, the trader profits from the divergence or the convergence in price action between the instruments that make up the spread position. A spread can have two legs or twenty-two legs. A true spread trade position is frequently thought to be "delta neutral" when it is first executed in the sense that each of the components zeroes out the others when added together ( it is hedged ) - but of course, there is risk in the trade. Most spread traders try to make adjustments for volatility between the individual spread component instruments ( the legs ).
Pure spread traders harbor the general conclusion that spread trading is more reliable and consistent than taking flat price directional bets on a single instrument. They might also be of the opinion that spread positions "behave" better than flat price instruments in terms of technical analysis and modeling.
Many legitimate spread trade positions are recognized by trading exchanges to carry less risk - and therefore, they almost always cost less to carry overnight than flat price positions. For example, the CME SPAN initial margin requirement for the July Crude Oil Future is $6,210 for an overnight position. You can carry a Crude Oil Jul-Aug-Sept 1-2-1 Butterfly Spread overnight for $472. All exchanges give SPAN margin credits for spread positions. They even have intra-exchange agreements - for example, ICE and CME have a mutual agreement for SPAN credits to carry a mini-Russell versus a mini-Dow stock index spread position.
I personally think that more "retail oriented" traders and "swing" or "position" traders should consider spread trading as a strategy. It works, it is consistent, and you can carry the positions for a long time for cheap.
There are certainly negatives with spread trading. The most obvious issue is that execution slippage has to be considered.
Arbitrage is technically a spread trade between two very highly correlated instruments - for example, physical gold versus Comex gold futures. Maybe even SPY versus ES, or ICE WTI versus Nymex WTI.
Some very advanced thinking types will use fundamental and statitistical relationships between instruments to scalp one based on the price action of another ( or several ). Some really advanced HFT firms use 'lead-lag' relationships on an automated basis.
I have inserted some examples in order to stimulate some discussion.
Most spread traders like what they think is "better, more predictable behavior" as compared to a flat price instrument. Spreads should generally trend better and certainly be less volatile. A good spread should be submissive. Spreads can be position traded for size on the cheap - but your clearing firm will charge you the haircut for each leg. Clearing firms love spread traders for obvious reasons. But again, you can carry alot overnight for ridiculously cheap.
Stock pairs, stock baskets, statistical arbitrage - gazillions of possible strategy combinations with stocks and ETFs. Note how the EQT + CHK versus UNG spread is far less choppy than the SPY index or even the XLE analog ETF. It is also just about the mirror inverse to the consolidated front month Natural Gas futures contract.
Serious juice in this one; nice down-trending channel for a long time and it looks like it's found some support.
Simple and obvious. Stevie Wonder could have seen this one:
And for the encore; an adult swim that my paying clients will surely be pissed about me posting. Sophisticated arbitrageurs are simply spread traders who don't bother closing legs. And then the fuckers go and automate it:
I personally like to use both statistical analysis and a specialized charting technical study in terms of spread trade entry signals. I always set my profit target and my stop-loss level at the time of entry.
If we enter into a hedged position using multiple instruments, the trader profits from the divergence or the convergence in price action between the instruments that make up the spread position. A spread can have two legs or twenty-two legs. A true spread trade position is frequently thought to be "delta neutral" when it is first executed in the sense that each of the components zeroes out the others when added together ( it is hedged ) - but of course, there is risk in the trade. Most spread traders try to make adjustments for volatility between the individual spread component instruments ( the legs ).
Pure spread traders harbor the general conclusion that spread trading is more reliable and consistent than taking flat price directional bets on a single instrument. They might also be of the opinion that spread positions "behave" better than flat price instruments in terms of technical analysis and modeling.
Many legitimate spread trade positions are recognized by trading exchanges to carry less risk - and therefore, they almost always cost less to carry overnight than flat price positions. For example, the CME SPAN initial margin requirement for the July Crude Oil Future is $6,210 for an overnight position. You can carry a Crude Oil Jul-Aug-Sept 1-2-1 Butterfly Spread overnight for $472. All exchanges give SPAN margin credits for spread positions. They even have intra-exchange agreements - for example, ICE and CME have a mutual agreement for SPAN credits to carry a mini-Russell versus a mini-Dow stock index spread position.
I personally think that more "retail oriented" traders and "swing" or "position" traders should consider spread trading as a strategy. It works, it is consistent, and you can carry the positions for a long time for cheap.
There are certainly negatives with spread trading. The most obvious issue is that execution slippage has to be considered.
Arbitrage is technically a spread trade between two very highly correlated instruments - for example, physical gold versus Comex gold futures. Maybe even SPY versus ES, or ICE WTI versus Nymex WTI.
Some very advanced thinking types will use fundamental and statitistical relationships between instruments to scalp one based on the price action of another ( or several ). Some really advanced HFT firms use 'lead-lag' relationships on an automated basis.
I have inserted some examples in order to stimulate some discussion.
Most spread traders like what they think is "better, more predictable behavior" as compared to a flat price instrument. Spreads should generally trend better and certainly be less volatile. A good spread should be submissive. Spreads can be position traded for size on the cheap - but your clearing firm will charge you the haircut for each leg. Clearing firms love spread traders for obvious reasons. But again, you can carry alot overnight for ridiculously cheap.
Stock pairs, stock baskets, statistical arbitrage - gazillions of possible strategy combinations with stocks and ETFs. Note how the EQT + CHK versus UNG spread is far less choppy than the SPY index or even the XLE analog ETF. It is also just about the mirror inverse to the consolidated front month Natural Gas futures contract.
Serious juice in this one; nice down-trending channel for a long time and it looks like it's found some support.
Simple and obvious. Stevie Wonder could have seen this one:
And for the encore; an adult swim that my paying clients will surely be pissed about me posting. Sophisticated arbitrageurs are simply spread traders who don't bother closing legs. And then the fuckers go and automate it:
