Starting out in spread trading

[SuperDriveGuy]

Hi,
I have been trading outright futures(mostly indice) for a year now. I now want to trade spreads and can see the potential with a market direction neutral strategy.

I am specifically looking to spread between 2 indices e.g DAX vs FTSE, where the ratio I guess is 2/5 ie 5 FTSE contracts for 2 DAX ones.

Currently(03 Sep 2009 12:06 UK TIME), the FDAX is trading at 5335 and the FTSE at 4825 and the difference being (5335-4825) 510 or roughly 1.1% of FDAX and this fluctuates, the FDAX tends to move more than the FTSE, hence I believe the spread opportunities.

Does anybody know of any strategies that one can use to trade the above scenario OR anything in particular to trade the indices against each other.

Please be aware I am not referring to same exchange spreads e.g ES, NQ or calendar spreads. So no margin advantage as such, also not referring to seasonal spreads as I am day trader and close my positions at market close.

Thanks in advance,

SDG

 

[HammerMan87]

Hi SDG, most equity index spreads tend to be mean reverting. Although not always. This would be a good place to start. Make sure you can find a way to chart the spread so you can see where the extremities lie.

HM

 

[SuperDriveGuy]

Hi SDG, most equity index spreads tend to be mean reverting. Although not always. This would be a good place to start. Make sure you can find a way to chart the spread so you can see where the extremities lie.

HM

Hi HM,
Thanks for that.

I understood in general about the indices being mean reverting and looking for extremities, but how do I go about calculating the mean? Is there a standard formula or some calculation you use?

I have eSignal and I can chart the difference between the two(FDAX-Z) in numerical terms 500... etc or a percentage 1.1%... etc
Regards,

SDG.

 

[HammerMan87]

I would take a look at Bollinger bands and MA channels. They tend to give you a good indication if price is out of line. Look to buy at the bollinger band (or MA channel) and take profits at the MA (and vice versa). Although, like anything make sure you at least visually test and paper trade any ideas to see if they work.

 

[SuperDriveGuy]

I would take a look at Bollinger bands and MA channels. They tend to give you a good indication if price is out of line. Look to buy at the bollinger band (or MA channel) and take profits at the MA (and vice versa). Although, like anything make sure you at least visually test and paper trade any ideas to see if they work.

Thanks HM!

Its great, now I have an idea how to trade the index spread. BB,KeltnerChannel and the like. Many thanks for the tip.

I will approach this with due caution as you suggested backtesting etc.

Regards,

SDG

 

[spreadbettingportal]

Thanks for the info

 

[kobza]

I trade 1FDAX against 3 EuroStoxx 50
it means 25Euro / 30 Euro

look at my video

Kob

Hi,
I have been trading outright futures(mostly indice) for a year now. I now want to trade spreads and can see the potential with a market direction neutral strategy.

I am specifically looking to spread between 2 indices e.g DAX vs FTSE, where the ratio I guess is 2/5 ie 5 FTSE contracts for 2 DAX ones.

Currently(03 Sep 2009 12:06 UK TIME), the FDAX is trading at 5335 and the FTSE at 4825 and the difference being (5335-4825) 510 or roughly 1.1% of FDAX and this fluctuates, the FDAX tends to move more than the FTSE, hence I believe the spread opportunities.

Does anybody know of any strategies that one can use to trade the above scenario OR anything in particular to trade the indices against each other.

Please be aware I am not referring to same exchange spreads e.g ES, NQ or calendar spreads. So no margin advantage as such, also not referring to seasonal spreads as I am day trader and close my positions at market close.

Thanks in advance,

SDG

 

[HowardCohodas]

I now want to trade spreads and can see the potential with a market direction neutral strategy.

A combination of spreads, e.g. a put credit spread and a call credit spread on the same underlying instrument at the same expiration is frequently named an Iron Condor. Iron Condors are usually considered a neutral strategy. However, the Oct 2010 expiration spreads were exposed to significant trending the last 30 days of their life. Yet, with effective management, one could have obtained more profit than was available had the market just moved sideways.

If you trade Iron Condors, don't panic if the market trends. In chaos, opportunity exists for those who seek it.

 

[Dommo]

I trade 1FDAX against 3 EuroStoxx 50
it means 25Euro / 30 Euro

Thanks - I am interested in how you choose your contract ratios.

Given the index ratios (approx 2.3:1) and contract sizes (2.5:1) I thought the usual DAX/STOXX contract ratio was 1:5, so your choice is interesting. Of course, I'm not accounting for typical relative movement in the indices.

Using a 1:3 ratio, wouldn't this mean DAX dominates? Would you get a similar trade/risk if you could simply trade a smaller size DAX contract (eg 10Euro) with no Stoxx hedge?

I also got the impression that DAX/Stoxx are tightly correlated, so that making money on a 1:5 ratio could be a slow process.

 

[kobza]

I choose the contract ratio following their own volatility and their own tick value

for my spread DAX/Stoxx, yes I overpound the Stoxx to calm down the Dax volatility, more than once I buy a spread and close it with the same price for the Stoxx, just gaining on the Vol of the DAX

To built the synthetic price of the spread I just use 1DAX - 1Stoxx

pls explain me more what we wrote
Given the index ratios (approx 2.3:1) and contract sizes (2.5:1) I thought the usual DAX/STOXX contract ratio was 1:5

The 2 contracts has to be correlated for me to trade them like a spread, without correlation, no business. the correlation take out big part of the risk of the financial market

 

[Dommo]

Thanks - I will explain what I meant:

When looking at an index spread I look at the ratio of the index value (DAX/Stoxx = 2.3 approx), rather than the difference (DAX - Stoxx). Futures contract sizes are in the ratio 25:10.

If both indices moved by the same percentage in the same direction (say 1%) I would broadly expect the spread trade to stay flat (ie no profit or loss).

6780 * 1% = 68 points, giving P/L of 25EUR/pt * 68pt = 1700EUR per future
2880 * 1% = 29 points, giving P/L of 10EUR/pt * 29pt = 290EUR per future

As best hedge, I would expect to take 1 DAX to 5 Stoxx contracts, so the PL would be +/- 250EUR (1700 - 1450). It's not a perfect hedge, but its the closest I can get with futures, unless I'm doing more than one DAX contract.

A similar calc is in section 5 of this doc:
http://www.eurexchange.com/download/documents/publications/Spread_Paper.pdf

With a ratio of 1:3 if both indices moved 1% you would have PL of +/- 830 EUR (1700 - 870). With this ratio, the DAX dominates, and 3 Stoxx contracts are only a partially hedge for 1 DAX contract. So, this is what interested me - why you chose 1:3. It seems that you are primarily exposed to DAX, and you might achieve similar DAX exposure (without any Stoxx hedge) more cheaply if you could trade in a smaller size (eg 10EUR per DAX contract). You could do this, for example with a CFD, if that is available to you.

As I said, I haven't studied the relative volatility on these indices. I did imagine that since the indices have common components and there is a lot of eurozone equity correlation, the ratio might move slowly.

I totally agree that you need a degree of correlation for a spread, and that this mitigates risk. But you don't want the underlyings to remain forever in lockstep - they need to deviate, otherwise there is no opportunity.

You may have another reason entirely for using 1:3, and I might learn something!

None of this is a criticism - I was genuinely interested in your choice of contract ratios, and there isn't much discussion here about index spreads.

Cheers

 

[the_winner_11]

That's hard not to agree with you actually)

 

[richardserrano]

Hello guys,
i am posting my trading plan and i would really appreciate your comments and analysis of it , this works 70% of the time however it is missing something and I would like to make it perfect. with your help

Trading Plan
First I look out for patters of over bought or over sold conditions the example that i am going to give you is an overbought condition.
Second I wait for the stockastic crossover diversion into an overbought condition.
Thirdly I wait for the macd crossover going into a diversion, a histogram diversion or double head.
Fourthly if the moving average is going to cross over I wait until the crossover has finished then I set up my fibonacci, wait until the price breaks the resistance level then wait for a signal like a shooting star or a doji, then short and set my fibonacci again. i get out at 38.2% or if the market is very week at 50%. Obviously this works perfectly if you can short right at the top.
My question is does anyone know of an indicator which lets me know how high the price can go. I am not sure this type of indicator exists.
i would love to paste the chart but i dont know how to do it in link in pls contact me if you want, i will send and email to you with the charts attached
i hope that your trading plans are going well.
RICHARD

 

[-oo0(GoldTrader)]

i get out at 38.2%

You can get out a lot closer using parabolic.

 

[kobza]

Richard, your trading plan, is bases for trading spreads?
kob

Hello guys,
i am posting my trading plan and i would really appreciate your comments and analysis of it , this works 70% of the time however it is missing something and I would like to make it perfect. with your help

Trading Plan
First I look out for patters of over bought or over sold conditions the example that i am going to give you is an overbought condition.
Second I wait for the stockastic crossover diversion into an overbought condition.
Thirdly I wait for the macd crossover going into a diversion, a histogram diversion or double head.
Fourthly if the moving average is going to cross over I wait until the crossover has finished then I set up my fibonacci, wait until the price breaks the resistance level then wait for a signal like a shooting star or a doji, then short and set my fibonacci again. i get out at 38.2% or if the market is very week at 50%. Obviously this works perfectly if you can short right at the top.
My question is does anyone know of an indicator which lets me know how high the price can go. I am not sure this type of indicator exists.
i would love to paste the chart but i dont know how to do it in link in pls contact me if you want, i will send and email to you with the charts attached
i hope that your trading plans are going well.
RICHARD

 

[-oo0(GoldTrader)]

I just think it is so lame to tell someone to look something up and expect them to see what you see, but cannot explain yourself.

I think you might need to look up what "fact" means.

Look it up yourself and post what you think it means. I have no clue at all why Hotch said to look up a word that has nothing at all to do with reading charts.

However, I don’t know why you think I listen to the news..

I believe it was you who said.

7) talking about bulls or bears being in control is only a rational fiction.

Who would be so lame as to be talking about bulls or bears being in control, if not the non-trading talking heads, reading scripts, on your very own TV?

No one at the gas station, or the market, or a filming location, ever talks to me about bulls or bears being in control.

The Fibonacci sequence is a natural pattern of action, and reaction.

Point 3) “Flags definitely fly at half mast.” Great phrase, but I didn’t get it.

When I went to school Edwards, and Magee, was required reading. The first time I made a good percentage return on a flag was in silver. The last time, well we might be in one now.

See: Flag chart

The breakout was pure Darvas, but the wedge may turn out to be a flag. And flags fly at half-mast. The first run up (usually five waves), is the pole. The second pole starts at the low of the flag. Then we look for another five wave upthrust.
Prices were around 20, made a flag, which will be flying at half-mast around 30, if prices get a little closer to 40.

Flags investopedia

Point 5)I believe that some people made fortunes by noticing where moving averages crossed over.

Kroll did a lot of work with moving averages. But you have to understand they are a lagging indicator. Sure they will always pick up a trend AFTER it happens, but the math behind them has no real predictive properties. Macd through the use of divergences, and exponential moving averages, sure can change direction quickly when the trend gets weak, but moving averages do not predict. Parabolic will respond to a change of trend quicker than moving averages. Moving averages are pulled from past price action. Parabolic is trying to fit prices to a pattern of nature, the parabolic curve. When Wells was drawing trendlines one day he picked up a parabolic curve instead of a straight edge. Before he knew what he was doing he say the curve fit the price better than a straight line. This led to the parabolic formula for trading human nature in price charts.

() A few seasonal spreads – must look into that.

Because seasonal charts use close only data. The smoothing makes it easy to see five wave seasonal thrusts, off of the second bottom of double bottoms.

No-one else has to-date picked up on my hints at Elliot Wave Theory ... Likewise, the ‘Head & Shoulders’ pattern is one which is traced by the price rather than imposed by the mind.

You cannot win this one. The pattern exists solely in the minds of traders. And not everybody’s mind at that. Prices are prices. It takes a mind and sometimes a great mind to make connections and place bets on these imaginary connections. Patterns do not exist outside of people’s minds.

Trading Plan
First I look out for patters of over bought or over sold conditions the example that I am going to give you is an overbought condition.

The terms overbought and over sold are misleading. Prices are never so low that they cannot go lower, (with stocks anyway because they can go to zero), and never so high that they cannot go higher.

Second I wait for the stochastic crossover diversion into an overbought condition.

You want to buy in that lower 20% but that does not mean the thing is oversold. It just means that a bounce is expected. Prices can hit zero and come back again into the lower area and continue the bounce.

Thirdly, I wait for the Macd crossover going into a diversion, a histogram diversion, or double head.

MACD is an excellent substitute for moving averages, but this will come later. Moving averages by their very nature are lagging indicators. They can come only after a price turn. After Stochastics which predicts, or parabolic which can turn on a dime.

My question is does anyone know of an indicator which lets me know how high the price can go?

Only a seasonal chart can do that. Not only how high but when.

 

[inktomii]

You should take a look at the ES/YM spread. The spread is calculated (50*ES)/(5*YM).