Spread trading is an integral part of the commodity futures marketplace, yet relatively little has been written about spreads. There are more fingers on one hand than books about spreads. Most books present little more than a cursory look at spread analysis. This book concentrates on the analysis of spreads and spread price action. Spread analysis is aimed at the discovery and execution of profitable spread trades. The seasonal spread texts are simply one of the tools the spread analyst uses. Before this book, futures periodicals have provided most of the published material about spreads. This book is like having an experienced spread trader mentor take you through his experiences and getting immediate answers. It is like attending a spread seminar headed by experts. It really provides answers. Courtney provides basic spread analysis techniques which stimulate readers to do their own research. Another goal of this book is to increase interest in spreads and provide the marketplace of ideas with a larger supply of spread trading analysts. Mr. Smith’s techniques will not make you a millionaire overnight. It didn’t do it for him. On the other hand, these techniques have provided significant profits when most traders were taking losses. Each reader of this book will acquire something different from it. Some traders will be attracted to the technical analysis, while others will prefer the fundamental and statistical analysis. The key to the successful use of this book lies in trying the methods outlined. Only through experience can traders understand what is being said. After reading this book, traders will must find the method they feel is the most profitable and best fits their perspective on the market, the one they feel most comfortable with.
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Over the years, commodity markets have increasingly caught the attention of investors and the general public. The rapidly escalating prices of 1973 and the explosion in 1980 probably did more to spark this interest than any event in recent times. Increasing volume and increasing value have been the hallmarks of commodity markets for many years.
In spite of the greater interest in commodities, spread trading has received little attention. Spread trading is the simultaneous purchase of one commodity futures contract and sale of a different contract. The contracts can be 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.
Spread trading has always been an important part of the commodity futures marketplace. Large commercial firms are often large spreaders that analyze and utilize commodity spreads in many ways. As a simple example, commercial firms frequently use spreads to move their hedges from one contract month to another. They trade spreads in an effort to recover the costs of storing and financing their inventories. They examine spreads to determine where they will deliver their particular commodity. These are but a few of the ways in which commercial firms utilize commodity spreads.
Large speculators are also heavy users of commodity spreads. It is not uncommon for large speculators to have more than one-third of their positions in spreads. Let's look at the wheat market as an example. On November 30, 1980, large speculative traders had 80% of their contracts involved in spreads! Why large speculators are so interested in spreads is examined in Chapter 3.
Nearly all spread trades are traded by either the large speculators or by the commercial firms. These sophisticated participants in the commodity futures market are knowledgeable about spreads and are extensive users of spread trading techniques. On the other hand, the small speculator is an infrequent user of spreads.
There are a number of possible reasons why small speculators don't trade spreads frequently. It could be because of the greater complexity of analysis: they must analyze two positions instead of one. The fundamentalist will have to analyze the relative supply and demand of two contracts rather than just the overall supply and demand. Analysis of relative supply and demand is a very subtle problem. It could also be that the majority of small speculators are not familiar enough with fundamentals to trade spreads. Most analysis of spreads centers on fundamental analysis, whereas most speculative analysis of outright positions centers on technical analysis.
In spite of these factors, the small speculator should be vitally interested in spreads. For reasons that are explained more fully in Chapter 3, the small speculator can improve profit potential by trading spreads properly. As the prices and volatility of commodity futures contracts increase, there becomes an even greater need for information on spread trading. Spread trading can provide a vehicle to decrease the volatility and the risk of futures trading. The two major approaches to analyzing commodity futures are called fundamental analysis and technical analysis.
Fundamental analysis is directed primarily toward the elucidation and analysis of the supply and demand situation. The fundamentalist will look at such factors as planting, exports, crop production, domestic disappearance, weather, and currency fluctuations. Fundamental analysis seeks not only to discover the factors that go into making the current price what it is but also to predict what those factors will be in the future.
Technical analysis can consider only those factors that marketplace itself is composed of. The technician will look at such things as price action, volume, and open interest to help determine an opinion of the market. The technician largely seeks to either describe or predict the market action. That is, she or he tries to describe the present market action and assumes that the current situation will continue in the future. The descriptive technician assumes that a market will continue for a long enough time to create a profitable trade. The predictive technician tries to discover technical factors that give insight into the future of prices, and is less concerned with the marketplace as it exists.
Many people believe the fundamentalist has the harder task. The sources of information, the sheer weight of the information, and the greater depth of insight necessary to analyze the information are all factors that make the fundamentalist's job more difficult.
It is no accident that the state of the art of technical analysis is more advanced than that of fundamental analysis. There are many books written about how to analyze the market using a technical basis. Books detailing fundamental analysis, however, are rare.
Both types of analysis are discussed in every chapter of this book, except Chapter 12, which is devoted entirely to some of the classic ideas of technical analysis.
The book is organized with the basics of spread trading in the first several chapters and the more esoteric subject in the later chapters.
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Table of Contents:
Chapter 1: Introduction
Chapter 2: answers the question What is a spread?
Chapter 3:outlines some of the reasons why a trader should trade spreads
Chapter 4 is a discussion of some of the reasons that spread prices move
Chapter 5 is a detailed analysis of carrying charges
Chapter 6 is an extension of the concepts outlined in Chapter 5
Chapter 7 is a special chapter on just interest rate spreads
Chapter 8 is devoted to the techniques involved in bull and bear spreading
Chapter 9 is the first of two chapters that use historical information in analyzing commodity spreads.
Chapter 10 discusses seasonal price behavior of futures spreads
Chapter 11 presents probably the first published discussion of linear regression and correlation analysis of commodity spreads
Chapter 12 outlines some of the classic approaches to the broad area called technical analysis.
Chapter 13 looks at those things that are unique to intermarket spreads or spreads of similar futures but traded on different exchanges.
Chapter 14 looks at spreads between different commodities and the factors that are unique to the trading of them.
Chapter 15 outlines the construction of a trading plan
Chapter 16 is a potpourri of trading tips that don't fit into any other chapter
Chapter 17 lists sources of further information.
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