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Spread Trading for Consistent Returns Spread trading is a unique
trading concept not all that familiar to the average commodity investor.
The typical commodity trader analyzes a particular market, either from a
technical or a fundamental standpoint, sometimes combining the two;
makes a determination as to whether the market exhibits either a bullish
or bearish bias, and then wagers by going long a futures contract or
purchasing a call option, or by going short a futures contract or buying
a put option. There are a number of variations on the theme, but the
idea is basically the same.
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The following demonstrates the inherent disadvantages, in the above
two scenarios, of an outright futures position or the purchase of an
option;
1. Size of account. The average investor has a limited account size,
and can only withstand a certain amount of drawdown associated with any
particular trade. The limited size of trading account necessitates the
placement of a protective stop order above or below the position. The
premature assumption of a position and the inherent volatility
associated with commodity markets leaves the position vulnerable to a
one or two day move that triggers the stop order, sidelining the trader
as the position oftentimes turns back around. As the market moves in the
trader's favor, the advisability of using trailing stops, adjusting the
protective stop in the direction of the trade makes sense in theory, but
oftentimes the market will open well above or below the stop order,
blowing out the stop and oftentimes taking away a substantial amount, if
not all of the profit that was being locked in.
2. Time. In the case of an options purchase, you are basically
purchasing time. As the purchaser of an option, the time clock and the
calendar become your worst enemy. The value of your option depreciates
as you wait for the market to move in your direction. Typically the
purchaser of an option witnesses the market go up and down, as the value
of his option changes, all along the remaining time value decaying on an
accelerated curve as the option expiration day grows nearer.
Spread trading on the other hand, is a way of effectively combating
the above two problems. Time no longer is an enemy and volatility, to a
certain extent, is effectively reduced. Margins are substantially less
due to the relative conservative nature of the "hedged" trade, which the
commodity exchanges themselves recognize. Margin requirements, for a
spread, can be reduced anywhere from 20% to 90%
Spread trading has no directional bias. The market can go up or down,
the trade is based only the relationship between the long and the short
position, i.e.- as long as the long side of your spread outperforms the
short side you will be profitable. Spread trades can be in the same
commodity with different delivery months (i.e. buy July Lean Hogs and
sell December Lean Hogs), or different commodities (i.e. buy March Swiss
Franc and sell March Australian Dollar). Generally speaking, both sides
of the trade will have the same overall directional bias, as in being
both long and short in the Grains (long July Corn/short March Corn) , or
in the Meats (long Live Cattle/short Feeder Cattle), or in the Metals
(long Gold/short Silver). This allows for the built in "hedge".
Seasonal spread trading is another opportunity to take advantage of
this manner of trading. As there are many seasonal tendencies associated
with various commodity markets, there are also seasonal tendencies
associated with seasonal spread trades. Seasonality is a seasonal cycle
that forms a similar, reliable pattern every year for many years.
Reliable seasonal tendencies are all around us.
Everyone is familiar with weather seasonality. In the winter months
the temperature is colder than in the summer months.
Farmers will plant crops and harvest crops at about the same time
every year.
In the summer months, Crude Oil is usually higher than in winter
(because people drive cars more in summer).
In the winter months heating oil is usually higher than in the summer
(because more people are trying to stay warm in winter).
At TransWorld Futures, www.TransWorldFutures.com, we go back over 30
years of research and analyze high percentage seasonal spread trade
patterns. If a commodity doesn't exhibit a high seasonal correlation, it
is tossed out of the data base.
Any spread trade that has been successful 80% of the time or better
over the past 30 years is certainly a possible candidate for exhibiting
a seasonal tendency and worth analyzing further. Once the high
percentage entry and exit dates are determined, it is time to examine
the trade on the technical setup. Is the spread overbought or oversold,
what are the resistance points? Basically does the trade look
technically as well as fundamentally sound. There are a number of
advisory services that offer seasonal spread trade recommendations based
on historical analysis, but, by ignoring the technical set up, may
result in entering the trade too early, resulting in unnecessarily large
draw downs, or in entering too late, missing the trade altogether. We
attempt to alleviate the stress, and do the leg work for you. The
results from this unique form of trading have to be seen to be believed.
Please contact one of our friendly brokers today, and learn about one of
the most consistent trade indicators.
Rob Rutger
Senior Analyst
TransWorld Futures
Rob@TransWorldFutures.com
Toll free: 1-877-843-4519
International: 011-813-241-1902
Fax: 1-813-241-1927
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