What is a Spread?
A spread trade consists of being long one market (or markets) and simultaneously being short in another market (or markets). Rather than trying to capitalize on the absolute change in the value of a particular market, the objective is to profit from the change in the price difference (spread) between markets. This is also known as a relative value play.
The Right Foundation
The foundation of an inter-market spread position is based on the fundamental relationship between two or more markets. For instance, gasoline and crude oil are related as gasoline is a derivative of crude oil. Corn and hogs provide an example of two closely related markets as feed prices represent the largest part of production costs for hogs and corn is the main source used for feed. These fundamental relationships provide the foundation needed for a legitimate analysis of the correlation between different markets.
While we have found a niche in the markets via the inter-markets spreads, it takes more than that to be a successful trader/investor. To trade or invest successfully, one must have three things:
- A methodology or system with an ‘edge’ or positive mathematical expectancy.
- The proper risk management strategy to keep you in the game and solvent during adverse market conditions
- The discipline to stay the course and follow both the trading methodology and risk management plan.
All three components are equally critical for success.