The complexity and jargon of spread trading can make it daunting to many investors. So today, I’ll show you a tool that can help limit your risk and exposure in volatile conditions like these. I’ll explain spread trading and weigh its pros and cons.
P.S. I’m about to release a spread trade for my Master Trader members. To learn how you can join them, risk free, click here.
Hi, this is Kevin Kerr for Uncommon Wisdom Daily.
We’ve been experiencing unprecedented volatility in the markets lately. In fact, even seasoned fund managers are scratching their heads and assessing their risk/reward trading strategies. But it’s important to understand that volatility is a double-edged sword. Yes, the risk can be extreme. But if handled right, it can provide incredible opportunities to make sizable profits.
The trick is being able to limit your risk and exposure, while at the same time maximizing your profit potential. That can be a difficult task. But today, I want to tell you about one tool that can make that objective much more attainable: Spread trading.
Spread trading intimidates many investors, because it can seem overly complex and foreign. But if we strip away all the jargon, spread trading basically just means taking a simultaneous long and short position in an attempt to profit. The profit comes from the differential, or “spread,” between the two prices.
You can find a spread in several places: Between different months for the same commodity; between related commodities for the same month; or between the same or related commodities traded on two different exchanges. In addition, spread can also be traded on stocks, options, ETFs and other asset classes as well as commodities.
One of the biggest reasons traders use this strategy is to cut down their costs. By buying and selling simultaneously, you can use your gains on one side of the trade to offset the cost of the other. Spread trading also helps you limit your risk. Of course, it also limits your profit potential. But many of the best traders are very risk-averse, so they’re okay with that drawback.
In order to decide if spread trading is right for you, it’s important to know all the pros and cons. On the pro side, the strategy can often offer lower margin rates, because it carries less risk. In other words, it cuts your initial costs. In addition, spreads are usually less volatile and prices move less quickly than with normal trading. This can be good if you’re a beginner who may be intimidated by the speed and price fluctuations of a single outright trade in the market. And third, spreads offer unique hedging opportunities in a variety of trading vehicles.
But now for the cons. Spread trading has much higher transaction costs, usually double, simply because you’re using more than one trading vehicle. That’s why it’s even more important to have an excellent entry and exit point, because every penny will count. Second, spreads are often not traded “outright,” so you have to leg into them using other investments. This can be tricky for the novice. Third, spreads can be less liquid than other trades, which can be a problem if you’re trying to get out of a position in a hurry. And fourth, as I mentioned before, spread trades have limited profit potential.
Another point I want to make about spread trading is that it can be an extremely effective tool in volatile markets, such as we’re experiencing now. But just like with all trading tools, figure out if you have a good reason for selecting it above any other investment.
If the answer is a clear yes, then go right ahead! But remember, keep an eye on those pesky transaction costs. They can really add up fast.
I’m Kevin Kerr for Uncommon Wisdom Daily. Thanks for watching.