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Spread Trading represents the simultaneous buying and selling of two related securities/contracts based on the expectation that their relative prices will converge. One can trade E-mini S&P with E-mini Dow – both are Stock indices and, henceforth, are correlated, as well as such pairs as Corn and Soy, Gold and Oil. Each position in the spread is called a leg. While trading the related assets one trades the difference or spread price between the two legs, simultaneously going long on one leg and short on the other.
Hence, a new instrument is created. The idea is that one contract will outpace the other in price, regardless of the price movement of the underlying assets they are based upon. As it is much easier to identify relative value than to predict market direction, spread trading has the potential to bring more reliable profits.
Spread Trading is usually market neutral, due to which the risks of macro-economic events affecting the long and short positions are being reduced.
Therefore, in spread trading there is no necessity to predict the market movement up or down in the future. Instead it is important to look for related instruments with a significant price gap, thus creating an attractive correlation between risk and reward. Correlated markets often change in the same direction but not at the same pace, and this makes it easier to identify the opportunities for trading. Thus, for example the Corn market can be stronger and move faster that the Soy market. Thus, once correlation is identified, the cheap stock or future is bought while the expensive stock or future is sold.
Spread Trading is not a subject to market manipulation i.e. running stops and a spread trader can be less concerned with liquidity and slippage. Another spread trading advantage is reduced volatility – especially if one tends to trade volatile markets like Crude Oil or Silver then spread trading helps to reduce volatility.
One important technical factor, that is worth mentioning in this connection, is the difficulty of carrying out serious technical analysis in the framework of spread trading on a trading terminal. Actually traders do not have a chance to create a chart of a relative combination of assets and to analyze it with various technical indicators. However, nowadays the unique analytical functionality of NetTradeX platform makes it possible to quickly and easily create charts, as well as to do complete technical analysis of simple and complex combinations of assets by means of GeWorko Method.
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