T2W Trading Community

Advantages of Spread Trading

There are so many advantages to trading reduced margin spreads that I hope I don’t run out of room here before I can tell you all of them.  Let’s begin with return on margin, i.e., yield.

Yield:  As I write this, the margin to trade an outright futures position in crude oil is $4,725, whereas a spread trade in crude oil requires only $540, only 11.4% as much. If crude oil  futures move one full point, that move is worth $1,000.  If a crude oil spread moves one full point, that move is worth $1,000.  That means either a 1 point favorable move in crude oil futures or a 1 point favorable move in a crude oil spread earns the trader $1,000.  However, the difference in return on margin is extraordinary:  In the futures the return is $1,000/$4,725=21%.  For the spread, the return is $1000/540=185%.  Think about that!

Leverage: This leads us to the next benefit of spread trading—with the same amount of margin, you could have traded 4 soybean spreads instead of one soybean futures.  How’s that for leverage?  Instead of making $250 on a five point move, you could have made $1,000.  Reduced margin spreads offer a much more efficient use of your margin money.

Trend: Earlier I said that spreads tend to trend much more dramatically than outright futures contracts. Not only that, but they trend more often than do outright futures.  I don’t have room here to show you the dozens of sharply trending spreads that can regularly be found in the markets, so we’ll have to settle for a recent one. You’ll have to take my word for it that this sort of trending happens frequently when trading spreads.

Opportunities: Because spreads tend to trend more often and more dramatically than do outright futures contracts, they offer more opportunities for earning money, and they do so without the interference and noise caused by computerized trading, scalpers, and market movers. Spreads avoid the “noise” in the markets. There are numerous reduced margin spread opportunities, enough to keep almost any trader busy. And it is the lack of interference by market makers and shakers that leads us to one of the most important advantage of trading spreads, whether they be reduced margin or full margin.

Invisibility:  One of the primary problems with any kind of trading in the outrights, whether it be in futures or stocks, is that of stop running. The insiders love it when they can see your order.  Even when your entry or exit is held mentally, they know where it is. They are keenly aware of where people place their orders. That is why they love Fibonacci and Gann traders. They know precisely where those people will place their orders. The same is true for anyone who uses one of the more commonly known indicators. The insiders fade moving average crossovers, and so-called overbought and oversold—regardless of which indicator is used to show either of those conditions. They know when prices have reached the outer limits of the Bollinger Bands, and they know the location of supposed support and resistance, etc. But with spreads, they have no idea of the location of your orders. You are long in one market and short in another. Your position is invisible to the insiders. They can’t run your stop, because you don’t have one. You cannot place a stop order in the market when trading spreads! Your exit point is entirely mental; it exists exclusively in your head. In that respect, spread trading is a more pure form of trading. It is the closest thing in trading to having a level playing field. Could that be the reason you hardly ever hear about spread trading?