Most American traders get confused when seeing the UK Spread Betting sites. They get completely the wrong idea of what spread betting is in the UK.
So to clear up this misunderstanding [and to give UK residents an idea of what spread trading means in the USA] here is a snippet…
Spread trading is the way the old-timers did it, and it is a way that still works. Spread and ‘seasonal’ trading are almost a lost art these days, and you have to wonder why! If you are a position trader, what better signal can you have than that this is the time of the year when the bonds have gone up 15 times in the last 15 years?
Spread trading is virtually a lost art except among professionals, who, by the way, have ‘never’ stopped using them since the beginning of trading.
There are a number of good reasons to trade spreads:
- Very low margin requirements.
- Much better odds of being successful than with futures or options.
- Every spread trade has you hedged. You give up the risk of price movement and replace it with the smaller risk of the differential in the spread.
- You are immune to stop running because you are in two different related markets, or two different months of the same market.
- Spreads take away much of the volatility of most futures trades.
- If you are only half right about the spread, you can drop the losing side and keep the winning side.
- You have the benefit of the fact that most seasonal spreads have very high percentages of being correct. Much more so than outright seasonal futures trades.
So why don’t more people trade them? Because the industry has kept the public largely ignorant of spread trading. How many books have you seen out there that deal with trading spreads? Yet trading them is simple. You buy one contract and sell a different contract at the same time via a spread order, or you leg into each contract on your own, as two separate transactions.
If you enter a spread by legging in, the computer will pick up the fact that you are in a spread and will hold you to only spread margins. Either way, you will pay two commissions, but the commissions are not a major factor considering that you will put up only fractional margins. Margins on spreads run about 1/5th to 1/4th those of outright futures trades.
For example: A trade in Soybeans will run you $1,350 per contract. But for a Soybean spread you will put up only $270, or 20% of the margin needed for an outright futures trade. Yet every point in the spread will be worth exactly the same as every point in the futures ($50). This means that the return on margin for a soybean spread is five times that of an outright soybean futures trade.
Spread trading is probably the best way to trade.. It beats both options and outright futures trades. It is far more relaxed than day trading. Much of the stress of trading is removed with spread trading.
All professionals still spread. Example….
Let’s say that in June you decide to buy a July Corn futures and that Corn is moving up sharply due to a lack of rain in the corn belt. You submit your order to the trading floor. Since all of a sudden everyone wants to buy Corn, the floor broker has trouble filling your order to buy. Although there is no requirement for a floor broker to sell to you [to make a market], he sells to you because he feels that it is his role to act in the capacity of a ‘market maker.’
What do you think is the first thing that floor broker is going to do once he sells to you? He is going to spread off on a back month of corn, or the same month in wheat or beans. He will hedge (spread) his position until he sees an opportunity to unload that short corn contract in a profitable (to himself) situation.
Apart from the profits made by an exchange, the markets exist for the benefit of hedgers. All hedgers are ‘spreaders.’ They are ‘long’ the underlying and ‘short’ the futures, or vice-versa.
