Spread trading allows you to put on a directional trade with a lower risk. A spread position is entered by buying and selling an equal number of options of the same class on the same underlying security but with different strike prices or expiration dates. Here are a few tips for beginners looking trade spreads.
Do your research
Small speculators don’t trade spreads frequently due to a greater complexity of analysis as it involves analysis of relative supply and demand of two contracts rather than just overall supply and demand. Despite this, you’ll be very interested in spreads as a small speculator because when traded properly spreads can improve your profit potential significantly with lower volatility.
So, it is worth doing your research on the securities you are looking to trade for any earnings announcements or any other key economic data that could potentially affect your trade. Always be updated with the latest news as well as the charts- never rely on technical analysis alone, fundamentals can make or break. So it is wise to keep a track of annual meeting dates, quarterly reporting updates, analysts’ ratings, dividend dates etc.
Paper Trade
Beginners can opt to paper trade for a while before they invest with real money. This will help you to take a closer look at your strategy. Plan where you are going to put your stop loss and why, and plan where you intend to take a profit and why and see if your strategy gives the desired outcomes.
Start on a small scale
If you are a beginner in trading or are new to spread betting, try to start smaller than you think you can handle as you will make some mistakes first and your leverage might just work against you. This is not to discourage but to really know what you are doing because as a beginner you might make decisions that can cost you in the long run. So it makes sense to get a deep understanding and hands-on live experience with smaller amounts before you go big!
Track market movements
Markets tend to move the most during the first 30-60 minutes of a trading session, especially when the US market opens. Whether you choose to trade or not during this time period depends on your risk appetite. Deal in sectors you understand well because if you are not well updated about the companies you should be tracking or do not understand the factors that might impact your positions, then you are just gambling! Make sure you know and understand your market segment well.
Low-Risk Strategy
Spread Trading has lower volatility/lower risk due to the hedged nature of positions. And due to lower risk you are allowed to put up a much smaller amount of margin money with exchanges. So essentially spread trading offers you a better reward/risk ratio than a given outright position.
Futures Spread Trading by large commercial firms
In commodity markets spread trading is the simultaneous purchase of one commodity futures contract and sale of a different contract. The contracts can be in different delivery months in the same commodity; they can be two different commodities that are related; they can be the same commodity traded in two different locations. As a commercial firm, you can use spread trades to move hedges from one contract month to another. This helps to recover the costs of storing and financing inventories.
Tax-Free in the UK
Spreading Trading is classified as betting in the UK and the proceeds from gambling are tax-free unless the spread trader/better has been identified as a professional gambler by Law (HMRC- Her Majesty’s Revenue and Customs) which is quite a grey area. There is also no stamp duty and no commission on each trade apart from the spread. Always be aware of the regulations active in your country of trading and of any taxes, stamp duty and commissions that might be charged.
Automate Spread Betting
Spread traders can develop their trading strategies into trading systems to enhance the strategy’s performance by reducing manual intervention. Trading systems can help remove constant market monitoring and emotion from trading. Various free strategy development systems available in the market can help build, backtest and optimize the spread trading strategy. So go ahead and add that extra edge to your strategy by automating it!
Next Step
You may also start learning popular automated trading strategies like ‘VWAP‘, ‘Index Arbitrage’, ‘Statistical Arbitrage’ and ‘Event Driven Strategy’. We also have a series of articles on ‘Statistics for Trading Strategies‘ explaining multiple aspects i.e. Historical data analysis, distributions, regression, correlation and co-integration.
