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For those of you that trade the futures markets, there are a lot of other things outside the future markets that you should be following. But, I guess my bigger message is for those of you that aren’t in the futures markets, whether you trade them or not, the futures markets have a tremendous impact on what happens in the other markets. That’s why you should soak up every piece of good trading knowledge like a sponge in a quest to clearly see the bigger picture.
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5-Ways to Make Money with Spread Trading vs.
Only 2-Ways with Open Position Trading BM
Commodity futures spread trading is fast becoming a lost art among average traders. Most Account Executives (Commission Sales People) seem not able to comprehend or really want to be bothered with spreads, as open position trades normally generate commissions faster. With one eye on the Lexus in the parking lot and another on the alimony payment to ex-wife, the last thing the average salesman wants is a slow trading spread.
However, much can be said for spreads. Let's compare spreading advantages with open position trading.
In a naked long trade, the market has only one way to go to make money, and that is up. In a naked short position, to make money, the market must go down. Any other movement means a loss, even a "wash" trade, because commissions still have to be paid.
In an average spread, with one sidelong and the other side short, the market can produce a profit under the following conditions:
1. One side can move up and the other stay unchanged.
2. One side can move down and the other stay unchanged.
3. Both sides move up, but one side moves up more than the other.
4. Both sides move down, but one side moves down more than the other.
5. One side moves up and the other side moves down at the same time.
Most of the time, the margin requirements for spreads are much less than the margin requirements for outright long or short positions, and sometimes, because of the nature of the spread and the seasonal factors involved, certain spreads are marked-to-the-market, which means that margin is only required to makeup paper losses if they occur in the spread.
Spreads are a blessing when markets go lock-limit up or down in that you are able to exit if you wish. Naked longs cannot escape a lock-limit down market, as there are no bids. Naked shorts cannot exit a lock-limit up market since there are no offers. The relationship between the legs of the spread is the only factor considered by the floor when you're entering and exiting during lock-limit days, so the trade, though not necessarily the best fill in the world, can be done over wailing and gnashing of teeth of those caught in the trap!
When it is difficult to determine whether a particular market is changing trend, comparing the back month's price action with front month price action may be a good indicator of whether the market is a bull or bear market. Chances are if the back months are performing better than the front months, you are in a bear market. The reverse could indicate a bull market environment. Spreading action may be justified in such cases to the trader's benefit. It's amazing how few traders pay attention to this rather obvious and readily activity.
Having at least a basic knowledge of seasonal trends can give the spreader immense advantage at times. We know that Wheat is harvested in June and July. Corn is harvested in the Fall. Isn't it possible to determine with the help of charts to go long the last month of old crop Corn and Short the first month of new crop Wheat sometime in the spring to take advantage of this natural process? Of course, other factors may enter the picture, such as planting intentions, supply/demand, etc., but the simple knowledge of this spread possibility should be profitable each year.
Wouldn't it be a good idea to also look at the relationship between different months in the same crop to weigh carrying charge premiums? Much profit has been made in spreads that were at full carry by buying the front month and shorting the back month in cases where carry is unusually wide.
The relationship between different currencies, bonds and notes, gold and silver, heating oil and unleaded gas, hogs and cattle, and many other commodity futures contracts is a fascinating study! It's much more interesting and much more profitable in relation to risk at times compared to open position trading.
Once the trader gets involved in spreading and becomes familiar with order placement and fundamental seasonal factors, he should find that perhaps his open position trading improves. He is more aware of the fundamentals and charts have more meaning.
His thought process is now expanded past the simplicity of deciding whether to go long or short. His timing, because of his new knowledge of seasonal spread factors is more precise. His ability to determine trends is enhanced, and best of all; his bottom line performance in terms of net profits in all his trading activities should show marked improvement!
I've covered only a few considerations in the preceding paragraphs. There are many more, such as the consideration of the "personalities" of the various trading pits, delivery points for different commodities and their impact on prices, differences between contract sizes in inter-market spreading, and whether a market is cash settled or subject to delivery. All these factors influence spreading.
Learn as much as you can about spreads. I consider them to be the secret to my trading survival longevity as a commodity futures trader! Good trading to you!