Edition 672 - April 28, 2017
Chart Scan with Commentary - The Secret of Reduced Margin Spreads
by Master Trader Joe Ross
Author, Trader, Trading Mentor, and Founder of Trading Educators, Inc.
One of the best kept secrets in trading is that of reduced margin spreads. You cannot name many ways to trade that provides more safety or a greater return on margin than does a reduced margin spread, while also being one of the least time- consuming ways to trade. Have you ever asked yourself why it is that many of the largest, most powerful traders trade spreads? I’m going to show you why!
WHAT IS A REDUCED MARGIN SPREAD?
Because of perceived lower volatility, exchanges grant reduced margins on certain types of spreads. Spreads consist of being long in one or more contracts of one market and short in one or more contracts of the same market but in different months—an Intramarket spread; or being long in one or more contracts of one market and short one or more contracts of a different market, and in the same or different months—an Intermarket spread.
DISTORTIONS ABOUT SPREADS
There are some distortions about spread trading that need to be dispelled. If we get them out of the way, I can show you the tremendous advantages spread trading has over any other form of trading.
It is said that spreads do not move as much as outright futures. I agree 100% with that statement. However, I believe that spreads trend much more often than outright futures, they trend much more dramatically than outright futures, and they trend for longer periods of time than do the outright futures. For these reasons you can make much more money with spreads than with the outrights.
The second distortion about spread trading goes like this: “You have to pay double commissions when you trade spreads.” Yes! You have to pay two commissions for every spread you enter in the market. So what? You are trading two contracts instead of one. You pay two commissions because you are trading two separate contracts, one in one place and the other in an entirely different place. Paying two commissions for two separate trades is hardly unfair. Let me tell you what is unfair—paying a round turn commission for an option that expires worthless. Why don’t you hear people complaining about that? You pay for a round turn, and you receive only half a turn. Doesn’t make a lot of sense, does it?
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 purer 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?
Liquidity: Attempting to trade in “thin” illiquid markets is one of the surest ways to encounter serious stop running and bizarre price movements. However, other than occasional problems with getting filled, spread trading does not suffer from a lack of liquidity—which in itself creates more trading opportunities. I would never consider taking an outright position in feeder cattle. Feeders are a thin, illiquid market normally best left to professional interests. But a reduced margin (feeder cattle)-(live cattle) spread is something I look for all the time. Some of the moves in this particular spread are incredible. They are worth hundreds and even thousands of dollars per spread, several times a year. They are highly seasonal in nature due to the birth and growth cycles of cattle. The same thing is true of spreading both live and feeder cattle against lean hogs. These spreads are seasonal, which brings us to the next great advantage to spread trading - seasonality.
Seasonality: Whereas seasonality doesn’t always take place as planned, i.e., seasonality can come early, late, or not at all, but when it is happening, you can see it. It is obvious when a seasonal trade is working as expected. Seasonality is not subject to the whims of man. Seasonality is one of the strongest reasons for trading spreads. Crops are planted within a given period of time. Calves and piglets are born according to their birth cycle and they grow according to their growth cycle. Even futures based on financial instruments are seasonal, and many of them offer reduced margin spreads.
Inversion: Along with seasonality comes the huge profits that can be made when an underlying market become inverted (goes into backwardation). This is true for any agricultural commodity as well as any financial instrument. I don’t have space here to explain inversion, but when it occurs, which is commonplace, the spread between front and back months can widen tremendously, thereby offering marvelous profit-making opportunities to the spread trader. As if that weren’t enough, the same opportunity becomes available when the period of backwardation ends and the relationship between front and back months returns to normal.
Probabilities: If we eliminate those trades in the outrights in which you get yourself whipsawed in a sideways market and maybe win or lose a little, the actual odds of winning on any trade is 50%. If you are long and prices move down, you lose. Conversely, if you are short and prices move up, you lose. It doesn’t matter how accurate is your trade selection, the bottom line is that your chances of being right once you enter a trade are one in two. However, when you enter a spread you are not primarily concerned with the direction of prices. Your primary concern is with the direction of the spread.
With a spread you can make money when both legs of the spread are moving up, both legs are moving down, when both legs are moving sideways but one more so than the other, or best of all, when the leg you are long is moving up and the leg you are short is moving down! As long as the leg you are long is moving better than the leg you are short, you will have a winning trade. There is only one situation in which you can lose with a spread, and that is to be dead wrong about both legs. So with a spread you can win even if you were wrong about the direction of price movement, as long as you’re not too wrong. The chart gives you an idea of what I’m talking about. Both months of this natural gas trade were moving down, but the spread was widening and moving up.
(Source Genesis Financial Data Systems)
There are additional opportunities in spread trading, including spreads that require full margin. You can trade spreads with stock indexes, sector funds, and single stock futures. Did you know you can daytrade stock index spreads? These are topics for another day and another time.
Unfortunately, either by accident or design, much of the truth of spread trading has been lost over the years. There are many more aspects to it than I have touched on here. Furthermore, there are some wonderful and inexpensive tools available that make spread trading a delight. Spread trading is one of the most relaxed ways to trade. It rarely takes more than 1-2 hours of your time each day, and more often than not, we are talking about only minutes per day to seek out and trade the wonderful opportunities that are available in reduced margin spreads.
Now that I’ve told you about spreads, my secret is no longer a secret.
To learn more about Spreads, click here!
© by Joe Ross. Re-transmission or reproduction of any part of this material is strictly prohibited without the prior written consent of Trading Educators, Inc.
Instant Income Guaranteed - HST Trade
Developer: Joe Ross
Administration and New Developments: Philippe Gautier
On 16th November 2016 we gave our IIG subscribers the following trade on Host Marriott Financial Trust (HST). We decided to sell price insurance as follows:
- On 17th November 2016, we sold to open HST Jan 20 2017 14P @ $0.15, i.e. $15 per option sold, with 63 days to expiration, and our short strike below a major support zone and 18% below price action, making the trade very safe.
- On 7th December 2016, we bought to close HST Jan 20 2017 14P @ $0.05, after 20 days in the trade, for quick premium compounding.
Profit: $10 per option
Margin: $280
Return on Margin Annualized: 65.18%
This trade was suitable for small accounts.
We have also added new types of trades for our IIG daily guidance since 2016, "no loss" propositions with unlimited upside potential, still using other people's money to trade.
Philippe
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© by Joe Ross. Re-transmission or reproduction of any part of this material is strictly prohibited without the prior written consent of Trading Educators, Inc.
by Professional Trader Marco Mayer
Educator for Forex and Futures, Systematic Trader, and
Creator of Ambush Trading Method, Ambush Signals, and AlgoStrats.com
One of the lessons I learned the hard way in trading is that to become and to stay successful as a trader, you have to be very open-minded. Unfortunately, this is easier said than done and many traders fail to stay open-minded in the long run.
This is a very common trap for traders you're having success early in their trading career. Maybe you started trading back in the early 90s when the stock markets moved from one high to the next. You learned a very simple long-only strategy to trade stocks and of course, you were very successful doing that. But in the year 2000 everything changed and that super bull markets turned into an ugly bear market. A completely new environment to trade in and guess what your long-only trading strategy stops working. But as you've been making nice money with it for almost 10 years it's very hard to stop trading it. On every little profit you make, you start hoping it might work again. But as the stock markets continue to collapse, so does your equity.
That trader can hardly be blamed for not being open-minded enough to see that and stop trading the strategy before it's too late. It's a very difficult thing to do. And that's why most traders who've had a very good start usually give it all back to the markets later on.
But there are also traders who've been around for a while that should know better by now. Still, they believe that only one way of trading is right and try to stick to it forever, happily ignoring all the facts telling them the opposite. Often, they're the ones who love hanging out in trading forums to tell everyone the truth about trading. Whenever someone wants to tell you "the truth about the markets", run as fast as you can!
If there is a truth in trading and the markets, it can be summarized in "it changes all the time". Whenever you think you've seen it all, something new happens. Truths like "bonds and stock market are highly correlated" simply become untrue. Whole markets become illiquid or disappear. Trading costs is another factor that can make markets untradeable (or tradable) for a specific strategy. And of course, market participants change all the time.
Because of that, trading strategies that worked for years can simply stop working. It will be very interesting to see what happens to many traders/strategies/hedge funds that are currently relying on some kind of long-only stock market strategies when things become ugly again.
So that's one of the reasons you have to stay flexible and open-minded in this business. Markets change. If you don't adapt, you won't survive.
But you also need an open mind to be successful in developing trading strategies and looking for market edges. Very often you'll find that the very opposite of what you believe or read in a trading book is actually true. But you won't find that out if you're not ready to challenge what you believe to the true right now. Is a certain chart pattern that is categorized as "bullish" all over the internet actually "bullish"? Or might the truth be that chances of success are much higher fading that signal? Go ahead and find out!
Also if a strategy looks like the worst strategy ever, maybe it's going to be a good one if you do the opposite? The same is true for indicators, think of new ways to use them. Maybe it's actually meaningless if an indicator hits a specific value where it's supposed to be "overbought" but it's an excellent indicator to show a change in momentum by looking at its change from one period to the next?
Other things traders tend to get attached to are specific markets or trading styles. "I trade only the EUR/USD and I never hold a trade overnight". Good luck with that! This means you'll hit some very serious drawdowns (or have to completely stop trading if you have a filter for that) whenever the volatility of EUR/USD gets too low to profitably day trade in that market. And these periods can last for years! As this can be true for whole asset groups like currencies, it's always good to be able to switch to wherever the action is (energy markets, bonds, stock indices for example).
Of course, when it comes to the actual execution part of trading, there's no room for you to be open-minded. Here you have to be 100% disciplined and stick to your rules and risk management. If you're open-minded about how much you'll risk on the next trade, you've clearly overdone it :)
Happy Trading!
Marco
© by Marco Mayer. Re-transmission or reproduction of any part of this material is strictly prohibited without the prior written consent of Trading Educators, Inc.
Blog Post - Avoiding Stress
by Professional Trader Andy Jordan
Educator for Spreads, Options, Swing/Day Trading, and
Editor of Traders Notebook Complete and Traders Notebook Outrights
Humans are not machines, stress is evident and how to avoid it is explained in Andy's latest blog post. Read more.
© by Andy Jordan. Re-transmission or reproduction of any part of this material is strictly prohibited without the prior written consent of Trading Educators, Inc.
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