Spread Trading: Explained

Spread Trading as we have already mentioned, helps to reduce market volatility and balances the relation between risks and profit. In order to identify the traded contracts, one has to create a chart and analyze it accordingly, and here is where GeWorko Method comes into play. It grants a unique opportunity for spread traders to effectively develop spread trading strategies, by constricting corresponding charts quickly and easily and use extensive arsenal of technical analysis tools.

Recently, financial markets have become more volatile and choppy. Taking into consideration, increasing risks, uncertainty and less predictability, there is an increased need for new trading methods. Traditional trading strategies working some decades ago tend to be out-of-date.

types of spread trading

Let us again define what the term ''spread'' means: it is the difference between Bid and Ask prices of the instruments. The activity when a trader simultaneously buys and sells two financial instruments related to each other (called legs), is spread trading. Here the profit is made out of the difference of the relative price changes of these two instruments. Thus, spread trade includes two equal and directly opposite positions. Spread trading may be used both in the market of Forex, commodities, indices and stocks.

Several types of spread trading may be distinguished: intra-market spreads, and inter-commodity spreads.

  • Intra-market spreads refer to simultaneous opening of a long and short position on the same underlying asset, differing from each other only in delivery date. Thus, one might trade September Gold vs. December Gold or July Oil vs. August Oil. This type of spread is also called calendar spreads and it is the most popular type of spread. The trader gains profit when either the long position rises faster than the short one, or falls more slowly than the short position. The most important advantages about this strategy are fewer risks and absence of the necessity to set orders for each position- long and short.
  • Inter-commodity spreads refer to opening long and short positions of different market assets that are related to each other (for example gold and silver). This instrument is based on the assumption of positive asset price correlation. The profit is made on the contrast of asset behavior on the market, and the fact of market correlation makes the trend prediction easier. It is natural that the risks of trading inter-commodity spreads are higher than trading calendar spreads, correspondingly, the higher the risks - the higher the probabilities of having profits. Here there can be 3 scenarios with a profit gain:
    • the rise of long position when the short one is falling
    • the rising speed of the long position is higher than the one of the short position
    • the falling speed of the long position is more slowly than the short’s one.

It may be concluded, that in spread trading profit is generated from the widening or narrowing of the gap - spread, between the two instruments. One of the keys to success in spread trading is the right combination of instruments, which form the spread. The spread between the trading instruments should generally fluctuate within a certain range; that is why it is important to choose instruments with high correlation and common characteristics. This can be carried out by constructing effective charts and carrying out technical analysis.

Find examples of applying GeWorko Method for Spread Trading Strategies.