Very few individual speculators trade futures spreads and very few speculators are profitable on a regular basis in the futures markets. Who trades spreads? Primarily hedgers and the professional speculators, and most professional speculators are profitable - otherwise trading would not be their profession for very long.
Perhaps then there is some merit to trading spreads. So why is it that most traders stick to trading only outright long or short positions? Perhaps there is a fear that spreads are too complex to trade and too difficult to understand. Perhaps it is laziness. Perhaps some who speculate in the futures markets are more interested in the excitement of trading than trading for success.
Whatever the reason, any trader entering the futures trading arena should have an objective of being successful, and to do that you must learn as much as you can about trading and the markets. If one is not willing to put that effort in, then one should not expect to be successful trading futures. Hard work is rewarded, and lack of effort will quickly find your trading account capital heading south.
So what is a spread? Quite simply it is a trade that consists of simultaneously going long one futures contract and short a related futures contract. An example would be a Buy December Corn/Sell December Wheat trade. A spread always consists of two “legs", a long and a short. They must be related though to be considered a legitimate spread. Buying gold and selling orange juice against it would not be considered a spread, as there is no relation between the two commodities.
In the example above, a trader does not care whether wheat or corn goes up or down in price. What is important in this case is that the price difference (the spread) between the two contracts widens. Any of these 3 scenarios will generate a profitable trade; corn increases in price more than wheat, corn decreases in price less than wheat, or the best case - where corn increases in price while wheat decreases.
When trading spreads, both legs are usually entered as one order with your broker. From the above example again, a possible limit order would read : “Buy 1 Dec Corn/ Sell 1 Dec Wheat, 5 cent premium to the buy side". Such an order tells your broker to put 1 spread on if it can be done with Corn at a maximum of 5 cents more than Wheat.
There are 3 basic types of spreads:
1) Intra-Commodity - also known as calendar spreads. The underlying commodity is the same on both legs, the only difference being the delivery months. e. g. Buy Jun Cattle/Sell Aug Cattle.
2) Inter-Commodity - where the underlying commodity is different (but related) on both legs. e. g. Buy Dec Corn/Sell Dec Soybeans
3) Inter -Market - where similar commodities are spread across different exchanges. e. g. Buy Dec Kansas Wheat/Sell Dec Chicago Wheat
Different spreads have different volatilities and risk associated with them. In general though, spreads can be a terrific way in which to manage your risk to the level you desire. Spreads also tend to trend more reliably than a straight outright position, allowing for great trading opportunities. There are also many seasonal trends exhibited among many spreads.
Spreads can be charted just like a normal outright position. A spread is normally represented by a single line on a chart, plotted as the difference between the two contracts. Spreads can therefore be studied using all the familiar technical analysis tools that are used to study an outright future.
While one should study and learn as much as possible about spread trading before risking their capital, it is clear that spread trading presents a great alternative method for speculators in the futures markets to develop a profitable trading plan, either on its own or to complement their outright trading methods. If professionals can consistently be successful trading spreads, why should the ordinary speculator not avail him or herself of the same benefits of spread trading?
Bryan Moffitt is the owner of Futures Research Corp. - a company that provides traders with valuable analysis and research to improve their trading success in the futures markets. To learn more about spread trading, sign up for a free 1 hour introductory webinar at http://www.futuresresearchcorp.com/Webinar.aspx