Tuesday, February 17, 2009

Spread Trading

In trading you need to move on, when it becomes crowded. There is still money to be made, but the moves become random, the edge you have erodes over time and you find that more and more setup's stop working, have not the follow-through you are used to or more and more trades hit your stop-level. Sure you can fine-tune and you should do that for a while, as you might just be slightly out of sync with the market. But when you start doing that it's also time to broaden your horizon. You need to look for new, greener pastures.

I'm doing that at the moment and you might find it interesting to take a look yourself, so I will add these thoughts here.
In trading you will seldom find something really new, what has changed is the velocity, what took days and weeks can now be made in hours and minutes. That change is true not only for equities and equity index futures, that is also true in commodities or bond trading.

I recently started looking at spreads, actually calendar spread trading. This chart shows the Spread between April Light Sweet crude and march Light Sweet Crude (CL J9 - CL H9)

Calendar spread trading is a very old trading technique, it works a lot better better in physicaly delivered contracts, than in money settled contracts, but it trends in both. What you will see, is that this spread has not a lot of momentum spikes and if there is one it is usually safe to fade it, as Oil is still Oil, the only difference is the delivery time. So spikes and freak moves seen in the individual contract to get the weak traders out, will not show on the spread chart, as the spikes happen in both contracts. Only the underlying trend will really move the spread, meaning get it right and stay with the trade. I have just ordered Keith Schap's book "The complete Guide to Spread Trading" which Newton Linchen recommended and whose website you might take a look to.

You can make war about the same meager bone or you can step aside and look for new bones outside of mainstream. These usually are bigger and safer to get than the ones thrown to the Wolfe-pack.


markus said...

Hi Chris,

I don't get it. What game do you think has become too crowded?


Newton Linchen said...


Thanks for the mention. Actually, I heard of this book at the blog of a fellow trader, Jeff Watson. http://masteroftheuniverse.wordpress.com

Jeff is a veteran trader, former pit trader, and he is writing a book (on trading) wich I am very curious to read.

He trades spreads and he is a good resource of trading ideas.

Best Regards,

Newton Linchen.

Globetrader said...

Hi Markus,

you will notice it, when your profitability goes down or setups no longer work as they used to work. If you have to ask, everything is fine for you, otherwise it might be prudent to broaden your horizon and look for new ideas. Trading is not static and you can either continuously adjust your setup, fine tune and get your head handed to you one day, because all that fine tuning exploded in your face, or you can stick with a valid, proven and working trading idea and look for instruments, which allow you to trade the way you like to trade.
I'm doing this. Extreme volatility kills my trading plan, as my account size does not allow me to move my stops to where they belong, when I look at my charts. That's the reason, why I'm looking for instruments or ways to trade, which make the most of my trading plan. If calendar spreads are the way I don't know, I just find them worth looking into and I'm dipping my toe into the water by trading the calendar 1 month oil spread.
Best regards,


markus said...

Hi Chris,

thanks for your reply.

The markets are indeed not static and every edge must be honed from time to time, so only an adaptive approach can have a long living.
On the other hand IMO it makes a lot of sense to concentrate on one or two markets and become really good at one approach/pattern which suits one. In general it does no good to jump from one market to another or from one play to another or both. Often you end up as jack-of-all-trades - which means you never get your edge honed.


Newton Linchen said...


This is an interesting post about spreads, on the blog "Quantitative Trading":


Take a look at it.



Anonymous said...

Are you still trading these Oil spreads? how volatile are they?