The Basics Of Commodity Spread Trading

If you’ve tried trading futures trading, many of the conservative techniques explained show you how to trade with the trend. Another aspect of conservative commodity trading, is commodity spread trading.

In order to delve into commodity spread trading, you need to understand the basics of trading futures without spreads. Let’s take a look at how this is done and understood by the commodity trading community.

The basis of trading straight futures is to profit either from the market moving higher or lower depending on the initial position that you entered. If your purpose was to buy or go long a certain futures contract, your directional bias would be up. If your purpose was to initiate a position that you foreseen the markets moving lower, than your directional bias for market pricing would be to move lower.

Without confusing the new trader, let’s just stick to the terms long and short. If you are long, than the directional bias is for the market to move higher in price from one’s entry point. If you are short than the directional bias is for the market to lower in price from one’s entry point.

Commodities also trade in different contract months, years and exchanges which allows the savvy commodity spread trader to take advantage of price disparities between these platforms to allow to make money in a conservative manner.

The commodity spread trader does not make money with a specific directional bias as pointed out in the explanations above, but makes money from the difference between two commodity contracts from either a different month, a different year or a different exchange.

For instance, July 2009 Corn could be trading at 2.02 cents per bushel and the Dec. 2009 Corn contract could be trading at 2.30 cents a bushel. I could utilize the difference in prices of these two contract months and profit if that price disparity widens.

Why are two same commodities priced differently?

Well, if the current month was March of 2009, the July contract would be closer to expiration and would than go to market based on the ending price of that contract, while the Dec. 2009 contract has many months to go.

In that time, there could be floods, storms, droughts, and over abundance or an under abundance of corn in the coming months. Also since delivery is further out in comparison from the July Corn contract, there is an added premium of storage that is involved with contracts set to expire further out.

Another analysis a commodity spread investor may take into consideration is seasonal adjustments. July Corn typically rises as the contract comes to expiration while Dec. corn typically falls as it gets closer to expiration.

Taking the seasonal price movement in these seasonally adjusted commodities, you can profit by taking the spread of the two commodity contracts and profit from it. Many savvy, patient and calculated spread traders wait for ideal situations that the market presents and then takes advantage of these disparities.

There are many spreads that you can look for in different commodities such as crude oil, soybeans cattle and currencies. In fact, the Forex marketplace is probably one of the more well known spread trading markets in the world as Forex gains in popularity.

If you look at currency pairs, you will see the price is a reflection of the difference from two different world currencies that create a new price for the Forex market. To prove that, take a look at the Japanese Yen, the U.S. Dollar, the British Pound and see how they trade individually on the CME exchange and than compare the prices it sets in the in the Forex marketplace. Prices are different because in the Forex marketplace prices are represented by the spread between two world currencies.

In closing, at first blush, it would seem that commodity spread trading takes more time for trades to develop, is more complex in structure and takes more time to understand the metrics on how you can profit trading futures spreads. But if you can have patience and study how pricing differentiates from different futures trading contracts in different months, years and exchanges, you can create steady, long lasting profits by trading spreads using futures and commodities traded contracts.

About the Author

Beau Penaranda writes on commodity spread trading and on how to trade commodities in general. Go to http://www.futurestradingsetups.com to read free information on how to trade futures.

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