Why Spread Trade?
The reasons we are compelled to trade spreads are four-fold:
- Spread trading may give us less correlation to other markets and/or trading programs.
- Since we get our entry/exit signals based on the spread price rather than the outright market, we are less likely to be competing for entry and exit fills with other trading programs.
- Spread trading may afford us alternative trading opportunities that outright long or short positions do not offer.
- A spread position has somewhat of a built-in hedge against severe market shocks. This is due to the fact that part of the spread position is long and the other part of the spread position is short. Certainly, this does not imply that spread positions are risk free. But in the event that all the markets across the board make a substantial and simultaneous decline -such as in a liquidity crisis like the 1987 stock market crash or the 2008 meltdown- or a substantial and simultaneous surge- such as in a currency devaluation or an abrupt shift in central bank policy- we have a chance that half of the open contracts we are holding will be positioned in the right direction
There are times when it seems that a trading opportunity or a trend/counter-trend setup in an individual market is not easily discerned. The result is that the system/trader is unable to get a clear signal to implement a trading strategy for that particular market. However, many times that same market is analyzed in relation to another market and a much more obvious outlook/set-up begins to emerge. Because of this, trading opportunities can materialize in market spreads even when opportunities may not be found in outright long or short market positions.