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Spread / Pairs Trading - the allure and the reality


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Spread / Pairs Trading - the allure and the reality

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  #1 (permalink)
 josh 
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To be market neutral and still make money--perhaps it's the holy grail of trading. To make money without having to worry about market direction...? Sign me up!

If only it were so simple. As I have examined spreading, on the one hand it is so promising; yet on the other hand, it seems to me (a newbie on the subject) that it is really not much different from trading outright direction. Why? Because the spread trade is trading a relationship, one which varies; we still must decide on a direction, just not the direction of a product--rather, the direction of the spread, whether it will widen or narrow.



A typical pairs strategy says to find the mean of the ratio over some period of time, and fade a move away from that mean back to the mean. In the following example is a 100 week mean of the ratio (using the HLC value of each bar) with two standard deviations on each side:



As you can see, such a strategy of buying the lower band and selling the upper band would have had some limited success, but some places would have resulted in a large drawdown or loss. Such a strategy depends on the ratio hovering relatively closely around the mean, and since 2002 the NDX has been steadily gaining strength vs the S&P 500, and as such has remained largely below the mean. In other words, it has been trending down. And as you can see, a mean reversion strategy would have failed miserably in 2000 and 2001, as the tech bubble burst and the Nasdaq fell out of bed. Buying it, with a view to a reversion to a mean, would have been disastrous.

So we have a major detail to fill in with this strategy, as is the case with any mean reversion strategy--which mean do we plan to revert to? I used a 100 week value; but why not a 20 week or a 30 day or a 200 day?

Even ignoring this detail, the more fundamental problem is this--we are still trading the direction of the spread. The direction was heavily up in the first two years on the chart. After that it has basically been down. A strategy which had played a move away from a mean in either case would have worked well, particularly in 2000-02 and in 2009-12. But if you did not know better, you might actually think that this chart was the chart of a stock or some other instrument, wouldn't you? So to make money trading pairs, you still have to get the direction right. Why? Because one instrument can just keep rising or falling in relation to the other--it does not have to revert to a mean. Similarly, just as with a stock or future or currency, the ratio can trend--but at some point it will stop. So, you cannot always employ a strategy which goes with the direction of the spread.

In short, you still have to trade this like it's a stock or other financial instrument. So why not just trade outright?

While I see the perceived benefits of spreading, when it's all said and done, I see no real practical reason to do this on a discretionary basis. An arb-style approach with HFT abilities will work for sure, but that market is all sewn up as far as I am concerned. So spread / pairs traders, I welcome your feedback--I would love to find out that I'm missing something simple and that I'm completely wrong, so please prove me wrong here so I can explore this avenue of trading further.

.

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 Big Mike 
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Josh happy to see you start this thread. I have lined up a seasoned pro for an advanced spreading webinar when I return from vacation. More details later.

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 mattz   is a Vendor
 
 
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@josh. nice post.

I don't trade spread and for the most part I focus on the direction, but this area always been of interest to me.
I have seen that people who utilize this strategy know quite a lot about the major stocks that influence(have larger weighted average) on a particular index. Further, they also observe due to their additional fundamental knowledge when there is a flow from tech (NQ) to industrial (YM) to blue-chip (ES) and vice versa.
So I think the correlations goes beyond just a chart analysis.

I like to observe especially during this bull markets how far the corrections go of one index versus the other.
From the recent corrections we had, the YM has corrected about 800 points from its top, versus the NQ that held pretty solid in my opinion due to the strength of the techs. This for example, tells me that now the NQ is a lot more solid and a long way to go before we see a major corrections on it. While we have encountered unchartered territory in ES and YM with new highs, we are nowhere near on the NQ which is still trying to catch up. It could be that the spread between all should be also done on a long term basis and give us better perspective where things are going.

In general, I agree with you that finding a correlations daily is a hard task.

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 vegasfoster 
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From a day trading perspective, I've never figured anything meaningful that would justify the costs. Question I have is does anyone do that or is it purely a swing thing? I dunno.

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From a day trading perspective, I've never figured anything meaningful that would justify the costs. Question I have is does anyone do that or is it purely a swing thing? I dunno.

Most of what/who I know in this area -- it's all about speed. That is why there are hot topics like X_Trader's Algo Design Lab (ADL) with server-side scripting, or CQG's Spreader (also server side), and now CTS T4 has an Autospreader (soon to be server-side). So the focus is all about speed and moving as much volume as quickly as you can.

I am aware of some others that take the "swing" approach to spreading but I admit my understanding of that starts to break down. Clearly there is an argument of operational overhead and efficiency just like directional trading, if your costs are 30-40% of your gross because you are going for 1-2 ticks, then swinging can dramatically improve it. But in my head I always picture spreading in terms of high frequency arb, where an edge is largely eliminated over time.

I've seen some really "odd" spreads, like not just calendar spreads but weird mixtures of energy and softs and the sorts. I can understand spreading similar indices like @mattz was hinting at, but I am not sure about the complexity behind spreading more complex vehicles, especially with multiple legs. Luckily that is an area of expertise in the trader I will be bringing on for the webinar.

But this is absolutely not an area I know enough about. That is why I wanted to bring on a seasoned pro trader to talk about it for the group. I have a lot to learn in this area. I can't even name any spreaders on the forum, I am not sure who is actively working this angle.... Maybe with @josh's thread they'll come out of the woodwork and clear some things up?

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 Nicolas11 
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Hi,

I think that the idea is indeed to fade deviations of the spread compared to its mean.

But only if the spread is built between 2 instruments which are highly correlated (actually: cointegrated), that is to say that the spread is strongly and quickly mean-reverting. There are statistical tests to check it (Augmented Dickey-Fuller, etc.)

I am not sure that there is an issue with the direction of the spread. For instance, let's suppose that:
spread = 2 * price-of-instrument-A minus price-of-instrument-B
If the spread is above its mean, we could sell 2 units of A and buy 1 unit of B.
The other way would not be logical, I think.

Nicolas

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 kevinkdog   is a Vendor
 
 
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I have been swing trading calendar spreads for a number of years. I trade most of the ags, softs, energies, etc.

Yes, you do have to get direction right for the trade to work.

You can forget about arbing spreads - people much smarter and faster have this locked down.

You have to be really careful when looking at any prices unless 1) they are settlement prices or 2) they are exchange traded spread prices. You can't just throw up a candlestick chart of Nov Beans minus July Beans and expect to get something meaningful. This is because last trade price times will be different. You could accurately chart the exchange quoted spread on Nov/July Beans.

Many times spreads tend to trend more smoothly than the outrights.

Ag spreads many times follow seasonal patterns. Summer 2012 was an exception to that, as I found out.

Many pros in Treasuries are spreading. I know a mid size hedge fund that always and only spreads.

Margins are greatly reduced for spreads, so you can probably trade more pairs, or greater size, than an outright account.

You can easily lose money. "How I Lost 1 Million Dollars..." is a great book on a Soybean spreader who got crushed (no pun intended).

You will pay double commissions for each trade.

Also, any kind of backtesting is a TON harder with spreads, even if you have access to the exchange spread feed (Tradestation, for example, in their infinite wisdom, does not offer the exchange spread feed in their data). You can't really do continuous contracts. I've written giant custom macro spreadsheets to perform some of this backtesting. It is a pain.


One thing to think about: spread trading might have opportunity because so few people take the time to look at it, and learn about it.

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 josh 
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Thanks for the replies so far. I took a simulated trade near the close yesterday to help me work through the process. For the current values of ES and NQ, to get a near-identical notional value, I traded 3 ES, versus 4 NQ. This is because my entry price of short 3 ES @ 1690 yields 3*50*1690 = $253,500 and 4 NQ @ 3160.81 yields 4*20*3160.81 = $252,864. So, this yields the best possible market neutral position as best I can determine.

Here is a shot of the positions as of a few minutes ago:


And here is ES and the spread below (60 minute chart). You can see that since I took the trade late yesterday, the spread has widened just a tiny bit, hence the trade is in profit a few hundred dollars, with the NQ strength overtaking the ES strength. My idea on this trade was for a continuation of a widening spread (smaller value). As you can see, the Nasdaq 100 has been much stronger than the S&P throughout August, and only since 9/10 has that relationship changed. So this is not a mean reversion trade, this is playing for continuation of NQ/ES strength.


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 josh 
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Nicolas11 View Post
But only if the spread is built between 2 instruments which are highly correlated (actually: cointegrated), that is to say that the spread is strongly and quickly mean-reverting. There are statistical tests to check it (Augmented Dickey-Fuller, etc.)

Thank you for the post Nicolas.

In short, I am a newbie at this. The sample trade I have taken and the examples presented are really probably the most basic examples possible. The math involved in doing proper trading this way and doing tests for cointegration requires far more than anything I have mentioned, and even understand at this point. I don't have matlab either, which I probably would need.

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 kevinkdog   is a Vendor
 
 
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josh View Post
Thank you for the post Nicolas.

In short, I am a newbie at this. The sample trade I have taken and the examples presented are really probably the most basic examples possible. The math involved in doing proper trading this way and doing tests for cointegration requires far more than anything I have mentioned, and even understand at this point. I don't have matlab either, which I probably would need.


FWIW: What a couple of long time spread traders have told me is that mean reversion worked well until 5? years ago. Now it does not model as well. I have never used mean reversion in what I do.

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 indiantrader 
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Hi Josh

Thanks for starting the topic.
One needs to determine direction of spread movement like outrights but it has advantages of low volatility, well defined trend/range, upto 95% margin credit in some combination and always holding a hedged position in a market without worrying about stop-loss hunting.
The ES/NQ spreads ratio will be different for different spread traders, some traders adjust it for volatility in addition to the dollar value and some neutralise it with tick-value. In your case study, every tick movement of ES(3 lots) will create $37.5 difference and every tick movement of NQ(4 lots) will create a difference of $20.
The daily ATR of ES is currently 14 and NQ is around 37 so one needs to adjust the hedge ratio based on volatility too.
In case of confusion, its best to use the hedge ratio recommended by CME so one is sure to get margin credit as well.
So in this case its 2NQ:1ES, so tick values are roughly equal and CME offers 70% margin credit for this spread.( see attached picture)
The z-score indicator helps one to identify extreme levels in order to trade mean reversion technique and I remember somebody on futures.io (formerly BMT) coded an autotrading strategy called Ninja-spreader based on z-score.
CME has some good educational material for spreads..here is one pdf manual for index spreads.

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 josh 
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Most people will probably not truly spread trade. But if readers of the thread can take away anything, it's that intermarket relationships can be useful. Sometimes they are obvious, sometimes they are not. Yesterday is one day in which the relationship between the NDX and SPX was so clearly skewed that it can lead to trading decisions which are clearly favorable.



If your overall market hypothesis involved being long intraday, which was easy to do based on the big Summers gap up, a look at how markets were performing after the first 30 minutes or so that buying the NQ or QQQ was not the best option. Look at how quickly it attempts a gap fill. While the S&P was clearly holding strong and making new highs, the NDX was making new lows. The divergence from INDU was even more glaring, as it was particularly strong early in the day. On the other hand, if you were looking to short these new highs, then YM and DIA were definitely not the best products to choose. The Nasdaq was very weak, so shorting it was a much better choice.

So even if you were not looking to spread, looking at how various markets are performing can give a good insight into options you have, instead of deciding that you only trade one product and nothing else. As mentioned earlier, these relationships can change, so it's not so easy as it looks, but I think that some useful ideas can be drawn from these relationships.

As an update on the simulated trade (which I expect on this time scale would typically last a week or two), it is >$500 more in the money since the post this morning showing the trade. This is an example of an intraday spread using the smallest size possible (3ES/4NQ) that has produced a very nice profit, given the small size. One could have traded this at the open and closed now, and it is not a high frequency arb type of trade, but not a swing trade either. It is really using the relationships mentioned earlier, and realizing that, while all markets are higher today, the NQ is the strongest, so it will yield the best bang for the buck.


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TheDude
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Josh - You start by suggesting you want a market neutral strategy - obviously you've realised spreads do not offer that.

They are market neutral if you are spreading the cash (owned) against a future. Thats a basis trade. Thats different. If you want market neutral as a retail trader, then you may want to look at delta neutral positions such as options.

In terms of spreads - sure you can trade them as an outright with TA - but then like you say, your success will be similar to that of most who rely on TA and totally ignore the real underlying drivers of markets. TA only offers 2 dimensions If only understanding markets were that simple!

OK you'll get reduced margin which is real neat when you get a grasp of position sizing when you get the edge.

Here's a few pointers:

Spreads model much better than out rights. Fly's even better. When they trend, they trend. ie they are more persistent and tend to (not always) have lower vola. Why?

You're trading fundamental differences between demand & supply.
Theres a great video here/futures.io (formerly BMT) from DTN on spreads. Watch it.

TAke a look at RBOB H4-J4. Look at her puke! I noticed a massive premium on J14 the other week looking at the curve. I couldnt see why. Who knows a lot about energy markets? Fat Tails of cousres! I asked him and he kindly explained the fundamental issue of refineries re-tooling this time of year. I'll let him explain if he cares to. Either way, with a traders mindset somthing, that premium difference isnt going to last. Trade it! We're not worried about the price of march or april, just the difference in price. It cant be sustainable. People will buy march rather than april or sell april to march buyers.

Either way, sure as eggs, soon after I discussed this with Fat Tails the spread is coming off as expected. Timing! Good prices are never round for long!

No TA involved. Just common sense.

Also consider seasonals. MRCI.com have some good stuff as do other sites.

Basically you are trading the difference in demand and supply. Sure some spreads will seem to mirror outrights, but if you look at various commdities front month- mid month, agaist mid month- back month you will notice stuff. Spreads can be a good leader to what outrights will do too when you grasp them and think what the curve is saying.

GL

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 josh 
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Some great posts guys, keep them coming--I will reply to them with comments and questions later in more detail. Just an update right now on my simulated trade. S&P got sold a few minutes ago but the NDX remains firm for the moment, so the spread continues to widen, and the trade becomes more profitable. I do like the fact that I'm not concerned with a single market's direction, but the relative strength of the two.



@ Big Mike, I really look forward to the webinar presentation you have coming on this subject. It seems to me that with a trade going into a reasonable profit, it would be an opportunity to do a scale/leg. Just like in an outright trade, I would guess that I could get some profit and better my average by maybe selling one of the NQ contracts at this point, and then if the spread narrows a bit, adding one back in. Or something similar.

Spread traders, is that the kind of thing you would look to do at this point?

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 indiantrader 
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@josh, There has to be some technical indicator to find out when the widening of the spread is ending and is about to narrow again.

Here is my ES/NQ daily chart, ES or the broader market has been outperforming the tech stocks for last one year, over last 2 months NQ has been outperforming on taper talks. Now that FOMC says no taper, the broader markets are now again set to outperform the tech sector till next FOMC.

So Long ES/NQ would be a good swing trade for next few weeks in a 4:10 ratio ( $50 tick value for each).

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 tflanner 
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I traded Treasury spreads (yield curve) for 10 years (electronically). For 9 of those years I never had a losing month and I made a very good chunk of change. I am an independent trader and I had several friends who had Prop shops with guys that traded nothing but spreads. In total there were hundreds of guys trading these spreads around the clock. It was more or less a mean reversion type trade. Today those Prop shops no longer exit and there are just a few guys left trading these spreads profitably. Mind you in the day I had friends that were 7 figure traders that are no longer trading spreads...in fact one 28 yr old kid made $6 mln in 2006.

Anyway, even when spreads were profitable to trade it was still directional. Why are guys no longer profitable trading spreads. As I stated I traded treasury spreads, Fed action (QE) has not helped and it did change the dynamics of the trade. Also, after the 2008/09 crisis a lot of players were forced out of the mkt and you no longer had a diverse set of players to keep the mkt in check. Most importantly though HFT's have made trading spreads very difficult. It is a speed game and you are constantly missing your 'legs' because they know exactly what you are doing. I used TT Auto Spreader beginning in 2002 and initially it was great. However, by 2008 it was not effective because of HFT's. The exhanges do have a thing called "implied spread" where it executes for you. That was helpful....

Anyway, toward the end I was miserable trading spreads and it trades like an outright anyway and the mean reversion quality of the trade really did not exist anymore. I would not deter you from trading spreads, but if u go down this path I would not scalp it because the HFT's will have u for lunch.

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 josh 
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Just for posterity, here is an accurate ES/NQ spread plotted on the bottom, with ES on top. ES and NQ are continuous back-adjusted contracts, and the sample used to calculate the ratio is 5 seconds, so this is a very high accuracy spread plot (as opposed to using a daily bar which cannot accurately show the highs and lows of the ratio since they almost certainly came at different times in the day).


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 josh 
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indiantrader View Post
The daily ATR of ES is currently 14 and NQ is around 37 so one needs to adjust the hedge ratio based on volatility too.

In case of confusion, its best to use the hedge ratio recommended by CME so one is sure to get margin credit as well.
So in this case its 2NQ:1ES, so tick values are roughly equal and CME offers 70% margin credit for this spread.( see attached picture)

The z-score indicator helps one to identify extreme levels in order to trade mean reversion technique and I remember somebody on futures.io (formerly BMT) coded an autotrading strategy called Ninja-spreader based on z-score.
CME has some good educational material for spreads..here is one pdf manual for index spreads.

@ indiantrader, thanks for mentioning the volatility adjustment. I read about this but have not studied much about it yet.

Regarding the CME margin credit, can you refer me to the CME page where you see that? I have searched and found a page at CME Clearing that has performance bonds and cross rate margin discounts but I don't see ES listed, only SP and the other big contracts, for some reason.


indiantrader View Post
@ josh, There has to be some technical indicator to find out when the widening of the spread is ending and is about to narrow again.

Here is my ES/NQ daily chart, ES or the broader market has been outperforming the tech stocks for last one year, over last 2 months NQ has been outperforming on taper talks. Now that FOMC says no taper, the broader markets are now again set to outperform the tech sector till next FOMC.

So Long ES/NQ would be a good swing trade for next few weeks in a 4:10 ratio ( $50 tick value for each).

The issue I have with a z-score or any other technical analysis approach is basically what I mentioned in my first post--why not just apply it to a stock or future by itself? Why spread it? What you are suggesting is to apply TA principles to the spread curve. Z-score just calculates the deviation from the mean, and as the chart I posted initially shows, depending on the time frame the mean is applied to, there is often very little reversion to the mean. So you have a technical reason, and a fundamental reason for the trade. @ TheDude seemed to advocate a fundamental-only approach to his RBOB trade, but then again he's very anti-TA anyway.

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Just for posterity, here is an accurate ES/NQ spread plotted on the bottom, with ES on top. ES and NQ are continuous back-adjusted contracts, and the sample used to calculate the ratio is 5 seconds, so this is a very high accuracy spread plot (as opposed to using a daily bar which cannot accurately show the highs and lows of the ratio since they almost certainly came at different times in the day).



Note that if you use continuous backadjusted contracts, using ratios will be incorrect for all but the current contract. It might not be wrong by much, but it will be wrong.

That statement also applies to any trading system that uses multiplication or division of the continuous, backadjusted price.

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I had an awful typo in the post above. Completely changed the meaning. It has been corrected.


If anyone does not understand my post above, please ask.

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 josh 
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@ TheDude , thanks for your reply. After having some time to look in depth, here are my responses/questions:


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Josh - You start by suggesting you want a market neutral strategy - obviously you've realised spreads do not offer that.

By market neutral I meant that the profitability of the trade does not depend on a long/short direction. The trade will be profitable if one product (or group) is relatively stronger or weaker than another product (or group). Is this not accurate to say it's market neutral?


TheDude View Post
In terms of spreads - sure you can trade them as an outright with TA - but then like you say, your success will be similar to that of most who rely on TA and totally ignore the real underlying drivers of markets. TA only offers 2 dimensions If only understanding markets were that simple!

Definitely I think understanding what drives a market is important. But for a short term trade, the driver is often not fundamental or explainable at all, and even for longer term trades to some degree this is true. Sometimes the fundamental driver is clear cut, but in today's markets much of the activity on an intraday basis is not created by anyone with a real fundamental reason. Would you disagree?


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TAke a look at RBOB H4-J4. Look at her puke! I noticed a massive premium on J14 the other week looking at the curve. I couldnt see why. Who knows a lot about energy markets? Fat Tails of cousres! I asked him and he kindly explained the fundamental issue of refineries re-tooling this time of year. I'll let him explain if he cares to. Either way, with a traders mindset somthing, that premium difference isnt going to last. Trade it! We're not worried about the price of march or april, just the difference in price. It cant be sustainable. People will buy march rather than april or sell april to march buyers.

(edit: I am looking at the chart at the moment but I don't see it apparently. What day was this?)
Great example--so you're saying that you saw H4 was much weaker than J4, got some info from our main man FT, and then felt that a reversion was imminent, so you bought the H4/J4 spread. Right? By the way, you plot the ratio of H4/J4, or the difference? I would think the ratio would be a more accurate way, but maybe with the same product and such similar prices, a change in percent will roughly model the absolute change in price.

Do you just scour various markets and look for anomalies like this, or do you have a set list of markets you track, or...? In other words, how did you find this inefficiency?


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Basically you are trading the difference in demand and supply. Sure some spreads will seem to mirror outrights, but if you look at various commdities front month- mid month, agaist mid month- back month you will notice stuff. Spreads can be a good leader to what outrights will do too when you grasp them and think what the curve is saying.

Excellent, thank you again for the reply, this will be helpful.

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The issue I have with a z-score or any other technical analysis approach is basically what I mentioned in my first post--why not just apply it to a stock or future by itself? Why spread it?

Perhaps because there is much more chance that a cleverly-built spread be mean-reverting than a given security. And there are statistical tools to check this capacity of mean-reversion. On this topic, you could refer to last book from Ernst P. Chan.

Nicolas

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Perhaps because there is much more chance that a cleverly-built spread be mean-reverting than a given security. And there are statistical tools to check this capacity of mean-reversion. On this topic, you could refer to last book from Ernst P. Chan.

Nicolas

Thanks Nicolas, I have read some of his stuff online but I will get the book (and MATLAB?!) and check it out!

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@josh ,

I would like to clarify that I have never traded spread. I am just interested in the subject.

R could be a free alternative to Matlab.

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@ TheDude , thanks for your reply. After having some time to look in depth, here are my responses/questions:



By market neutral I meant that the profitability of the trade does not depend on a long/short direction. The trade will be profitable if one product (or group) is relatively stronger or weaker than another product (or group). Is this not accurate to say it's market neutral?



Definitely I think understanding what drives a market is important. But for a short term trade, the driver is often not fundamental or explainable at all, and even for longer term trades to some degree this is true. Sometimes the fundamental driver is clear cut, but in today's markets much of the activity on an intraday basis is not created by anyone with a real fundamental reason. Would you disagree?



(edit: I am looking at the chart at the moment but I don't see it apparently. What day was this?)
Great example--so you're saying that you saw H4 was much weaker than J4, got some info from our main man FT, and then felt that a reversion was imminent, so you bought the H4/J4 spread. Right? By the way, you plot the ratio of H4/J4, or the difference? I would think the ratio would be a more accurate way, but maybe with the same product and such similar prices, a change in percent will roughly model the absolute change in price.

Do you just scour various markets and look for anomalies like this, or do you have a set list of markets you track, or...? In other words, how did you find this inefficiency?



Excellent, thank you again for the reply, this will be helpful.

I really should try and stop posting if I havent read the full thread I should also stop posting when Im overly tiered. Sorry for the confusion....

I trade commodity calendar spreads usually holding for a few days or weeks - so they aren't really market neutral. They will tend to drift in the same direction as the front month if you're looking at the first few spreads or so. I see now though that your looking at ES-NQ which is kind of market neutral in that your trading the over/under performance of one index against the other rather than the direction of the stock market. This trade could offer great opportunities for long term trades around economic cycles. From memory, the tech sector outperforms the market in the early recovery stages. I dont trade inter commodity spreads because I got my fingers badly burnt in a live cattle-hogs trade. The the short went sky high, the long puked! Im scarred from that! Cals are nice and simple. 1-1. No ratios or anything.

I didnt realise you were looking at trading these intraday. To my thinking, any spread or market is going to be driven by news and sentiment primarily. Intraday, its mostly trends caused by people moving in and out of positions and trading round positions. So a daily trend will persist for longer and is easier to get a grasp of. I intraday outrights. Nothing wrong with day trading spreads. Loads of people do.

As for RBOB:



As you see, it starts breaking out of a range around the 9th, and really gets going on the 16th Margin is $550 init, $500 variation. If you entered on the close of the 9th, you'd have just under $4000 on a 10 lot taking very little heat. The spreads not that wild because your trading the 2 adjacent months. If you traded Jan-April, you'd probably have more, but obviously the margin may be more.


I found it here:

Open Contracts Spectrum

Look at Gasoline. There's still a massive distortion in April. I really like this page for looking at commodity curves. Hogs wheat and Nat gas are all looking a bit funky at the moment. Its also a good sanity check - you want to be short spreads (narrowing) contango markets, long (widening) spreads in backwardation. Same idea as trading with the trend.

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 indiantrader 
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@josh

Here is the margin credit information about ES vs NQ

https://www.cmegroup.com/trading/equity-index/us-index/e-mini-nasdaq-100_performance_bonds.html

Check equity index and select ND-nasdaq, it will show synthetic pairs, the ratios recommended by CME and the margin credit offered by them.

Regarding z-score, it s mainly used for pairs that show fairly good mean reversion.

The spread pairs like synthetics (ES:NQ,CL:BRN,Corn:wheat), calenders have a tendency to diverge and form a trend...its these spread pairs for which TA indicators can be applied.
The spread pairs like butterfly, condor, synthetic interexchange( CL vs WBS-ICE or cash vs futures or interexchange corn/wheat spreads) show a tendency towards mean reversion where z-score works well.

I am still training with Peter Hamby (SpreadProfessor), but my understanding is this.

High correlation, High co-integration---->trade for mean reversion
High correlation, Low co-integration-----> trade for diversion/widening of the spread pair

Basically, the opportuniy for a spread trade arises when the correlation is out of place temporarily, so pairs with correlation coefficient of 0.95 and less but more than 0.85 are favourable pairs.

There is one webinar on Advantage futures website on trading spreads.
Trading the European Yield Curves - YouTube

He describes the spreads construction like TED and butterfly Vs Butterfly where most of the charts look like a horizontal channel and trades are taken at extremes of the ranges and target the mean.

Correlations can be studies at Commodity Systems Inc. ? EOD Market Data and Trading Software by subscribing to the correlation lab service and it shows quite interesting findings eg. Light sweet crude and brent have just 61% correlation for the last 2 years

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 indiantrader 
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@TheDude

I checked the link to your page but it seems the spike in open interest you showed in J14 does not seem to be there on CME page.
I am attaching the OI list here.

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TheDude View Post

As for RBOB:

...


I found it here:

Open Contracts Spectrum

Look at Gasoline. There's still a massive distortion in April. I really like this page for looking at commodity curves. Hogs wheat and Nat gas are all looking a bit funky at the moment. Its also a good sanity check - you want to be short spreads (narrowing) contango markets, long (widening) spreads in backwardation. Same idea as trading with the trend.


@TheDude , His Dudeness, duder, El duderino,

You always have the greatest links, thanks for that. In your trading, how are you dealing with seasonality? are you taking advantage of it?, trying to avoid it? ignoring it?

.
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indiantrader View Post
@TheDude

I checked the link to your page but it seems the spike in open interest you showed in J14 does not seem to be there on CME page.
I am attaching the OI list here.


It's not OI, it's the all important price!!

Look how prices are in a fairly even state of carrying charge from Jan to March, then there is a massive jump in the price in April, where the curve goes into backwardation to the end of the curve. Thats what the Scarr Trading page is showing - prices along the curve, not OI.

I've never really used OI much in spread trading, but now you mention it, it could be a great thing to look at combined with COT data perhaps?

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@TheDude , His Dudeness, duder, El duderino,

You always have the greatest links, thanks for that. In your trading, how are you dealing with seasonality? are you taking advantage of it?, trying to avoid it? ignoring it?

Thats a good question.

It really depends.

I use MRCI for seasonality data - but there are other suppliers too. I tend to see if the current market is behaving according to the last 5 years - which I find more reliable than the 15 year pattern. I look for a period when the 5 year shows good acceleration.

If the market is going the opposite way, and there is some news story to suggest why - such as the drought causing shortages in corn last year, then I'll take that and override any seasonal pattern.

There are other spreads I'll take based on mispricings in the curve. OK Fat Tails suggests the RBOB is in fact a seasonal issue. It never came up in the MRCI seasonal report, but that doesnt mean they get every seasonal pattern - maybe in the last 15 years, the trade never did much?


If spreads interest you, you want to look at MRCI IMO. a subscription is pretty reasonable value IMO. Im pretty sure they offer a trial. You want the MRCI Online subscription, not the weekly report.

Heres a link to their results - assuming you took every trade mechanically - which in fairness they dont advise doing. The spreads way outperform outrights.

https://www.mrci.com/results/2012results/

Quite a few of their monthly spread trades are in fact FX 'spreads'. I dont like these as to my thinking USD-BP - USD - Yen is really a Yen-BP outright! You also dont get any or very little margin relief. Their Treasury spreads are also assumed to be ratioed at 1-1 so again you wont get margin relief - like I say, its reseach, not adivory. You need to decide which trades suit you. Some people here will love their FX spreads if they have an FX account and just trade the cross rather than a futures 'spread'

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 josh 
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TheDude View Post
As for RBOB:



(edit: kevin answered this below but leaving the original here for posterity)

I hate to beat this dead horse, but I don't get the same spread that you do here. Just a sanity check--are you plotting the ratio of H4 to J4, or is there a tradeable calendar spread from CME that you are showing here? I could not find any such product in my search but I may have missed it. I generated the chart below using minute-to-minute RBH4 and RBJ4 data. I'm also not sure what the histogram at the bottom of the chart is showing--too low to be volume for either contract in question.

This being said, I just don't see the same mismatch as I see on your chart. While it's true that there is a large difference between H4 and J4, as the charts show and as the web site you pointed out shows, from what I can see from a visual inspection, as well as the numbers, the difference and ratio has stayed pretty close. From a day-to-day basis, based on the data here, it looks to me as though the difference between the two has stayed in a pretty tight range.


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@TheDude thanks again,

For a long while now I've wanted to play around with calender spreads, more specifically trying to build a portfolio of them. Seems now is a good a time as any. I'm probably going to run it in sim through the rest of the year and then Ill put some capital behind it.

I've lined up about 5 different trades going into the end of the year, but I was a little excited to get started so today I put on a short /ZSX13-/ZSQ14 @64'4





I Just plan on holding this (!SIM!) until I roll into different trades at the start of october.

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I hate to beat this dead horse, but I don't get the same spread that you do here. Just a sanity check--are you plotting the ratio of H4 to J4, or is there a tradeable calendar spread from CME that you are showing here? I could not find any such product in my search but I may have missed it. I generated the chart below using minute-to-minute RBH4 and RBJ4 data. I'm also not sure what the histogram at the bottom of the chart is showing--too low to be volume for either contract in question.

This being said, I just don't see the same mismatch as I see on your chart. While it's true that there is a large difference between H4 and J4, as the charts show and as the web site you pointed out shows, from what I can see from a visual inspection, as well as the numbers, the difference and ratio has stayed pretty close. From a day-to-day basis, based on the data here, it looks to me as though the difference between the two has stayed in a pretty tight range.




Josh -

I am confident that you cannot rely on 1 minute data for RBH14 and RBJ14 to give you an accurate chart (maybe if you used bid/ask prices, not last traded price, you might be OK). You have all kinds of spurious spikes - prices that were never attainable. Below is the exchange traded spread feed, which differs greatly from the chart you show.

If you are using RBH14 and RBJ14 to construct your chart, the only prices I'd believe in are the settlement prices.


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Here's the individual data charts, with 5 minute bars. You can see that trading is infrequent for both products.


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 josh 
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Below is the exchange traded spread feed, which differs greatly from the chart you show.

Beautiful, that's exactly what I am looking for. This is CME, and is it a tradable product, or just a synthetic that must be legged into? What data feed is it you are plotting? (and which software as well? looks nice). For IQFeed I see some crack spreads but I do not see an H14-J14 spread for RBOB.

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Beautiful, that's exactly what I am looking for. This is CME, and is it a tradable product, or just a synthetic that must be legged into? What data feed is it you are plotting? (and which software as well? looks nice). For IQFeed I see some crack spreads but I do not see an H14-J14 spread for RBOB.

It is an exchange traded spread, so you can definitely trade it. There is almost always decent bid/ask in these spreads.. My chart is from the Tradestation Futures 4.0 platform, which allows you to trade exchange spreads. Ironically, Tradestation's main platform does NOT allow charting or trading of exchange spreads - pretty frustrating.

I'd check with the IQ guys, maybe they have the exchange spread available.

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It is an exchange traded spread, so you can definitely trade it. There is almost always decent bid/ask in these spreads.. My chart is from the Tradestation Futures 4.0 platform, which allows you to trade exchange spreads. Ironically, Tradestation's main platform does NOT allow charting or trading of exchange spreads - pretty frustrating.

I'd check with the IQ guys, maybe they have the exchange spread available.

Excellent--I'm assuming the exchange is CME. I'm curious as to which broker would provide a tradeable spread (other than Tradestation) like this. I bet CTS would, but I'm not currently using their platform.

This thread has turned out to be very informative, thanks to all the folks who are contributing--please keep it coming guys, I feel like I'm starting all over (in a good way) learning this stuff.

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Excellent--I'm assuming the exchange is CME. I'm curious as to which broker would provide a tradeable spread (other than Tradestation) like this. I bet CTS would, but I'm not currently using their platform.

This thread has turned out to be very informative, thanks to all the folks who are contributing--please keep it coming guys, I feel like I'm starting all over (in a good way) learning this stuff.

CME - yes. Most brokers offer these, I'm guessing. I traded them with 4 or 5 different brokers over the past few years.

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 tigertrader 
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There are a lot of good points that have been raised here; not the least of which is the comment from @vegasfoster "i've never found anything meaningful that would justify the costs". Any strategy that mitigates risk, is going to mitigate profit, also. There is always a price to pay, and the market is always going to extract a risk premium. If you aren't trading exchange traded spreads and executing the spread outright, you are going to have 2X the slippage and 2X the vig, on top of the risk premium you are paying. In the pit, at least, you got the edge on the least liquid or deferred contract, and attempted to get the edge in the front, and either leg the spread on the bid, or a tick better. You also had a rather sizable bid to lean on in the spread paper. And in addition, commissions were not an issue. During roll, I would routinely have 2000 calendar spreads on in the 30 year that I would take home overnight. In contrast, my hands would be shaking when I carded up a 50 lot outright in the bonds. That should give you an idea about the difference in volatility between spreads and outrights. Once again, there's a price to pay for the reduction in volatility.

However, @TheDude does bring up some very valid points in reference to term structure and spread relationships, although I would like to see some empirical evidence that supports his claim that spreads are more persistent than outrights. Nevertheless, spreads do present actionable mispricings, and can often provide valuable information that is a precursor to market turns and even regime changes. On a longer timeframe, spreads can reflect fundamental differences in supply and demand, but in shorter timeframes, variances in spreads are more of a flow-oriented phenomenon, not a value- oriented one. Which is the reason why legs in the same spread can be positively correlated and negatively correlated intraday. And, as is in the case with outrights, flow can trump fundamentals for longer than the average leveraged trader can tolerate.

Bottom line is, I have no less than a dozen spread charts on my workspace, all of which I consider invaluable. They are an inherent component of my methodology, yet I do not consider myself a spread trader. I may initiate spreads when they get out of whack, in a mean reversion strategy, but more often than not, I will leg out of one side of the spread into an outright position. Obviously, spreads are scalable and you can trade size, and there are times when both legs may be profitable when trading a reversion strategy, but in the strictest sense of spread trading, you're trading the spread differential, which is generally less volatile, and one side is going to be outperforming the other. Pragmatically speaking (especially in an electronic venue), you get more bang-for-your- buck trading outrights.

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 josh 
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@ tigertrader , I knew you couldn't resist the allure of this thread!

From the very brief amount of information I have read so far, and from the info presented on this thread, I get the impression that it's not really a bang-for-the-buck issue, but rather an issue of what one's opinion is that he wants to express in a trade. If you think that the discretionary sector is set to outperform health care, you can express that opinion and not care whether both will rise or fall with the rising or falling tide of the broad market. That opinion can't be expressed by an outright long or short position in either sector. Maybe they will both suck, or both do great, but that's not what you care about in this case.


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Nevertheless, spreads do present actionable mispricings, and can often provide valuable information that is a precursor to market turns and even regime changes. On a longer timeframe, spreads can reflect fundamental differences in supply and demand, but in shorter timeframes, variances in spreads are more of a flow-oriented phenomenon, not a value- oriented one. Which is the reason why legs in the same spread can be positively correlated and negatively correlated intraday. And, as is in the case with outrights, flow can trump fundamentals for longer than the average leveraged trader can tolerate.


This sounds like a good point--and this was what I was saying earlier in the thread about using technical analysis for a spread trade--that intraday movements are, IMO, not really about fundamentals or supply and demand. As "proof," open interest in the ES contract rarely fluctuates more than a dozen or three per day; it's clear that the bulk of the volume that is trading intraday is short-term, day-trader/HFT noise that has zero to do with anything long-term fundamental. So your paragraph here really brings about the question of the method of analysis used to determine whether to buy or sell the spread.

I have not calculated any real examples of cross-margin discounts (would appreciate examples if anyone here has some), but I get the impression that one can get a quite large bang for the buck spreading versus outright, largely due to the very reason you mention--that the volatility is lower. I haven't run the numbers yet, but it seems with the margin discount, that one can actually get a similar bang for the buck compared to outrights, due to larger spread positions that can be held overnight.


tigertrader View Post
Bottom line is, I have no less than a dozen spread charts on my workspace, all of which I consider invaluable.

You knew I was going to ask. Let me just guess a couple:

1) NOB - 10y / 30y
2) high yield or investment grade corp bonds (using JNK or LQD maybe) / 10y or similar US treasuries
3) 10 year Bund / US 10 year
4) Gold / something
5) Crude / something
6) S&P / Nasdaq,Dow?

As an aside, with a spread trade I really like the idea of having a simple loss limit on the trade (in dollars), in the event that I'm just wrong about the direction of the spread, without having to make that be about where the market will trade. You can't really get your stops run with a spread, or so it would seem, at least not in the traditional sense.

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 SisyphusStone 
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Hi Josh,

Just had a quick skim over the thread, so apologies if I am repeating here. Have a look at some Aussie software called PairsTradeFinder.com as it might be what you're looking for.

Co-incidence (>0.9 ideally) is currently regarded as the best measure of a pair's likelihood of profitability on a reversion to the mean trading basis. You are looking for a pair to push out/stretch to at least 2 standard deviations from its mean and then look to trade a reversion until it crosses the 1 SD. Normal practice is to trade equal nominal value ie $1000 each side say, so divide each underlying's price into 1000 to give the position size. Typically stop losses are not used but rather time. One advantage of pairs/spreads trading is that you are not prone to being 'jabbed' out by market maker stop running games.

With Spreads you need to use line on close charts for prices

As for playing pairs/spreads on a directional basis I would suggest studying Wyckoff in order to 'read' the price action. Plenty of good threads on the methoidology here on futures.io (formerly BMT), but if you google 'Wyckoff Schematic' that will get you started. The added bonus is it will divorce you from a reliance on lagging indicators!

Hope that's of some help and good luck.

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 tigertrader 
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josh View Post
@ tigertrader , I knew you couldn't resist the allure of this thread!

From the very brief amount of information I have read so far, and from the info presented on this thread, I get the impression that it's not really a bang-for-the-buck issue, but rather an issue of what one's opinion is that he wants to express in a trade. If you think that the discretionary sector is set to outperform health care, you can express that opinion and not care whether both will rise or fall with the rising or falling tide of the broad market. That opinion can't be expressed by an outright long or short position in either sector. Maybe they will both suck, or both do great, but that's not what you care about in this case.

@josh: If I want to express myself, I'll write a poem, or post a comment on futures.io (formerly BMT). I trade to make money and I execute in a way that will afford me the best chance to make the most amount of money. And, if one wants to do this for a living and not a hobby, then the sooner they implement this strategy, the better.

I wouldn't recommend reading books on the topic. The majority of them are written by authors who make their living from writing books, not trading. They tend to be theoretical and their validations are all done post hoc. I like to gain my insights from a) individuals that know more than me, and b) individuals who have a proven track record executing the methodologies I wish to learn; but most often through my own heuristic process.

Market relationships are constantly changing, the information is complex, and the learning process is implicit. So, your solution is not reading more articles, books, or threads; the value of any piece of information you read is probably zero or worse yet, misleading or irrelevant to current markets. The real solution is to do your own homework and make your own observations.

Nevertheless, here's a tip (remember, it's value is probably zero): Don't rely on single data points. Instead, look for consilience, or a convergence of uncorrelated signals, to provide strong conclusions.

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Beautiful, that's exactly what I am looking for. This is CME, and is it a tradable product, or just a synthetic that must be legged into? What data feed is it you are plotting? (and which software as well? looks nice). For IQFeed I see some crack spreads but I do not see an H14-J14 spread for RBOB.


Hi Josh - yes it's on CME/NYMEX. It's an exchange defined spread - meaning you can trade it as a product, and if you like leg out, or leg in, and trade out in 1 - or any combination there of.

I see your using IQ Feed. So do I. The symbol is qrbh14-qrbj14 (or if you use Ensign qrbh4-qrbj4). Spreads on CME/CBoT have the @ prefix, so corn will be @ck414-@cu14, wheat @wu13-@wu14. Crude spreads would be qclv13-qclu14, Nat Gas qng...... You get the picture I'm sure....

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However, @TheDude does bring up some very valid points in reference to term structure and spread relationships, although I would like to see some empirical evidence that supports his claim that spreads are more persistent than outrights. Nevertheless, spreads do present actionable mispricings, and can often provide valuable information that is a precursor to market turns and even regime changes. On a longer timeframe, spreads can reflect fundamental differences in supply and demand, but in shorter timeframes, variances in spreads are more of a flow-oriented phenomenon, not a value- oriented one. Which is the reason why legs in the same spread can be positively correlated and negatively correlated intraday. And, as is in the case with outrights, flow can trump fundamentals for longer than the average leveraged trader can tolerate.

Bottom line is, I have no less than a dozen spread charts on my workspace, all of which I consider invaluable. They are an inherent component of my methodology, yet I do not consider myself a spread trader. I may initiate spreads when they get out of whack, in a mean reversion strategy, but more often than not, I will leg out of one side of the spread into an outright position. Obviously, spreads are scalable and you can trade size, and there are times when both legs may be profitable when trading a reversion strategy, but in the strictest sense of spread trading, you're trading the spread differential, which is generally less volatile, and one side is going to be outperforming the other. Pragmatically speaking (especially in an electronic venue), you get more bang-for-your- buck trading outrights.


Sorry, no empirical evidence here - just observations and experience. Ive traded loads of crude spreads where the daily outrights have been stuck in a range, but the spreads have been trending like a MF'er.

The bold highlights seem to answer your question in a way? The nearest thing I could perhaps refer to is the MRCI results I provided a link to. Not ideal though - basically 180 spread trades over the course of 2012 making >$100k trading 1 lots v 180 outright trades making a big fat zilch - suggesting a propensity to trend more? interesting that this seems to suggest that the less risky spreads are returning more than the more risky/volatile outrights, implying that less risk does not necessarily equate to less return at all? Since 1990 (4140 spreads and 4140 outright trades) spreads returned $800,000, outrights a cool $1,000,000 (approx) Although the spreads returned $200k less, I'd rather be trading them as the reduced risk and margin would allow us to blow outrights out of the water assuming we were using the same capital base. Here's the link again: https://www.mrci.com/results/2012results/

I agree 100% with what you say with regards to intraday price and daily price. I was trying to say just this a while back - but not so eloquently as you

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TheDude View Post



The nearest thing I could perhaps refer to is the MRCI results I provided a link to. Not ideal though - basically 180 spread trades over the course of 2012 making >$100k trading 1 lots



Where in the document do they state that the results are based on 1 lot only? I couldn't find a reference to that.

If it's really based on 1 lot, then it sounds too good to be true. Or, as I'm a believer of "no-free-lunches" I would expect the same strategies to generate a loss in the same magnitude in other years (or smaller losses for several years in a row). But then one has to question how much less risky these strategies really are…

Otherwise Mr. Moore and Mr. Toepke must be VERY rich men!

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 tigertrader 
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Spread / Pairs Trading - the allure and the reality-kawallerfutures.pdf

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Where in the document do they state that the results are based on 1 lot only? I couldn't find a reference to that.

If it's really based on 1 lot, then it sounds too good to be true. Or, as I'm a believer of "no-free-lunches" I would expect the same strategies to generate a loss in the same magnitude in other years (or smaller losses for several years in a row). But then one has to question how much less risky these strategies really are…

Otherwise Mr. Moore and Mr. Toepke must be VERY rich men!

lol.

Spread Ratio 1:1

'What is the ratio of contracts listed in your Spread Trades?

Unless explicitly stated otherwise, MRCI research always features spreads in a ratio of 1:1.

In such cases where the pricing and size of contracts differ, there is always the question of whether and how to balance it.
For the sake of simplicity, and because the industry refers to and quotes such spreads in terms of nominal price difference, MRCI has chosen 1:1.

Last Updated on Thursday, 03 January 2013 12:07'


They do emphasise these are hypothetical results. I dont think they are using any kind of risk management. The computer spits out optimised dates from past years and they blindly enter and exit accordingly. They always emphasise that the trader should apply his own management methods. These are not trade recommendations, just research. The results are for illustration. Could a trader do better with risk management and trade filters based on fundamentals or TA? Some of the drawdowns on these trades can be pretty big - so in other words, most would find trading like this quite challenging. Also there may be quite a few spreads on at the same time as some last for days, others 4 months+ so capital allocation is a non issue in the illustration. But if we did work out the amounts of initial and variation margin to trade every suggestion, would 100k be such a fantastic amount of return? 100k isnt really a huge amount of money in a year is it? It's kind of low for an average/good trader.

If you do the math, 100k is just over 8.3k on average per months worth of suggestions/trades. With 15 trades per month, that means the expectancy of a trade is approx $553. If the average holding period of each trade is 45 days, then thats just $12.3 per day per trade. Commissions and slippage arent factored in. It also assumes the trade was entered and covered at the daily settlement price - which is kind of tough to know in advance

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karoshiman View Post
Where in the document do they state that the results are based on 1 lot only? I couldn't find a reference to that.

If it's really based on 1 lot, then it sounds too good to be true. Or, as I'm a believer of "no-free-lunches" I would expect the same strategies to generate a loss in the same magnitude in other years (or smaller losses for several years in a row). But then one has to question how much less risky these strategies really are…

Otherwise Mr. Moore and Mr. Toepke must be VERY rich men!


Before you get too excited, realize there are no stops, to trade each spread would take a significant amount of capital, and that some of their trades have the wrong ratios.

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 josh 
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tigertrader View Post
If I want to express myself, I'll write a poem, or post a comment on futures.io (formerly BMT). I trade to make money and I execute in a way that will afford me the best chance to make the most amount of money. And, if one wants to do this for a living and not a hobby, then the sooner they implement this strategy, the better.

@tigertrader , veering a bit off topic here, but I'd like to briefly explore this.

I think you make an important distinction between expressing an opinion and seeing a trade opportunity. If I simply look at a spread ratio and think, "hey, the NQ has been really outperforming the ES lately, I think I'll sell the ES/NQ spread because it's likely to continue," then this seems to fall into the category of expressing an opinion. Kind of similar to what you said here:


tigertrader View Post
recent price action both stationary and dynamic illustrates that the prediction game may be an interesting intellectual pursuit, but, is in no way a pragmatic way to trade.

although its very difficult to implement, the optimal strategy and mindset for success is to think of oneself as simply an observer; not a trader, but an opportunist, which means you do not initiate "arbitrary" trades that inevitably degrade your P&L but, only take advantage of "obvious opportunity" which entails sitting idly by, allowing questionable trades to go uninitiated, and levering up when real opportunity is presented

So, you take a trade, not really because you want to express an opinion about what might happen, but because you see an opportunity, and want to exploit or seize that opportunity. I don't know if it would be going too far to say that something has to happen; maybe you could say that there is a catalyst that must occur that makes the opportunity something you want to act on. Either way, you are taking the trade because the opportunity for profit exists, not simply because you have an opinion and want to risk money to see if you are right. I think the distinction is important that you have made, if this is indeed the distinction.

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kevinkdog View Post
Before you get too excited, realize there are no stops, to trade each spread would take a significant amount of capital, and that some of their trades have the wrong ratios.

Hi Kevin,

thanks.

What do you mean by "wrong ratios"?

Cheers,
k

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karoshiman View Post
Hi Kevin,

thanks.

What do you mean by "wrong ratios"?

Cheers,
k

For some intermarket spreads, the correct ratio (the ratio that the exchange lists for margin) is not one to one. For example, MRCI lists the USTY spread as 1:1. This NOB spread is usually not 1:1 Unveiling the Mysteriousness of NOB Spreads | RJO Futures

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 tigertrader 
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josh View Post
So, you take a trade, not really because you want to express an opinion about what might happen, but because you see an opportunity, and want to exploit or seize that opportunity. I don't know if it would be going too far to say that something has to happen; maybe you could say that there is a catalyst that must occur that makes the opportunity something you want to act on. Either way, you are taking the trade because the opportunity for profit exists, not simply because you have an opinion and want to risk money to see if you are right. I think the distinction is important that you have made, if this is indeed the distinction.

Yes @josh, it is.

it goes right to the heart of the decision making process.

in a perfect world, where we are perfect;

we would always employ logic and unbiased heuristics in our decision making,

and not allow stress, cognitive load, and emotions to non-linearly affect the process,

the real holy grail as it pertains to trading.

so, its not so much a catalyst,

as a consilience, or a convergence of uncorrelated signals,

that provides a strong conclusion.

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I know a few full time prop spread traders, trading US Treasuries/Eurex interest rates. They are trading the yield curve.

My understanding is that the most attractive thing about this sort of spread is the way the spread works when the trade is not in your favor.

In laymans terms, the trade will become profitable faster as it moves your way but lose money more slowly when it moves against. As has been said, it is still effectively a directional trade but the direction of the yield curve.

Trading 2 correlated stocks that have gone out of synch is statistical arbitrage and that is what I generally think of when I hear about pairs trading. To me, that seems more of a high frequency game than yield curve trading but on stocks I am sure there's plenty of pairs that can be arbed without being an HFT guy. I think there's a fundamental aspect to pairs trading stocks in terms of figuring out if the divergence is because of a change in the underlying fundamentals or not.

Then there's calendar spreads which might involve you doing zany things like actually storing a bunch of oil for 3 months to take advantage of a pricing disparity.

Then crack spreads that trades off oil/gas against their derivative products.

I am sure it is very difficult to do a generic analysis of pairs trading because there's a lot of different spreads out there and they all have different characteristics, you'd need to become quite familiar with them to form an educated generic opinion. It is something I want to look into more but with so much on my plate, it never really gets priority.

From what I have seen, the prop traders that lean towards spread trading tend to get onto a funded account in less time than those that stick to outrights. If I wasn't so lazy

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 tigertrader 
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I'd "crack" a joke about trading the "crack", but it just seems... too easy a target !



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 josh 
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As a quick update--the sim trade initiated here is currently in profit $2740.

NQ profit = (3222.50 - 3160.80) * 4 * $20 = + $4936
ES loss = (1690 - 1704.50) * 3 * $50 = - $2175

Net profit = $4936 - $2175 - comms ~= + $2740

The DJIA has been so weak relatively that a short there instead of ES would actually almost be yielding a profit, or at least breaking even, so you'd have an NQ long free and clear for a $4900 profit.

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tigertrader View Post
I'd "crack" a joke about trading the "crack", but it just seems... too easy a target !



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Indeed...

As if the guy that invented the term "crack spread" didn't realize the double entendre he'd created!

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 SisyphusStone 
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Indeed...

As if the guy that invented the term "crack spread" didn't realize the double entendre he'd created!

I believe he was also responsible for coining the expression "Splitting Hairs"...........

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 josh 
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ES/NQ sim trade is now +$3600.

+$3800 on the NQ long, and only -$200 on the ES short. The cool part is that I'm not worried about being stopped out unless a dollar loss is reached. Kind of like, "go ahead, run the stops, I don't have one."

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 josh 
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ES/NQ sim trade is now $5800 in profit.



The ES leg is actually in profit, with NQ staying very strong. First circle is the spread where the trade was entered, second is current. A two week sim trade may not be too exciting for some people, but this has demonstrated how the trade works at least, which was the only purpose.

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josh View Post
ES/NQ sim trade is now $5800 in profit.



The ES leg is actually in profit, with NQ staying very strong. First circle is the spread where the trade was entered, second is current. A two week sim trade may not be too exciting for some people, but this has demonstrated how the trade works at least, which was the only purpose.

Excellent!

Well done Josh. Get a few more of these under your belt and you'll be ready to go. Wait for a few losses to come in first though. I dont mean that in a negative way - but as we know, learning how to take a loss is key in this business.

Given the lower risk you're taking as a spread, the higher propensity for the spread to move - probably down to cyclical factors, and the lower margin, you see how spreads can be a good money machine.

FYI the 180 day correlation is 96, 30 day is 94 - some may say thats too high, but you're making money. It's best to stick to higly correlated pairs to start off - but remember I dont have too much experience trading inter commodity spreads. May be as correlation is declinig in the short term, thats where you're edge is?

Out of curiosity I wonder what a fly would look like consisting of es-nq spread against an nq-ym spread?

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 SisyphusStone 
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josh View Post
As a quick update--the sim trade initiated here is currently in profit $2740.

NQ profit = (3222.50 - 3160.80) * 4 * $20 = + $4936
ES loss = (1690 - 1704.50) * 3 * $50 = - $2175

Net profit = $4936 - $2175 - comms ~= + $2740

The DJIA has been so weak relatively that a short there instead of ES would actually almost be yielding a profit, or at least breaking even, so you'd have an NQ long free and clear for a $4900 profit.

Josh, you might find this short vid from Tom Sosnoff of interest. From about 15min in there's an example with MA and V, but the rationale behind AAPL vs QQQ (= 1NQ) is worth considering.

https://www.tastytrade.com/tt/shows/MT/episodes/1337

SS

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Out of curiosity I wonder what a fly would look like consisting of es-nq spread against an nq-ym spread?

Thanks for the encouragement and info @TheDude . Do you mean to short the ES-NQ spread as I did here and then buy the NQ-YM? If that's what you mean, it would be doing damn well right now. Russell and Nasdaq have been super strong in the last 2 weeks, relative to the S&P which has been flat to down, and the Dow has just been a dog and has been particularly weak since the 9/18 high.

I thought a fly was usually constructed such that one product was hit twice, and the other two were bought once. So for example, buy the NQ/YM and sell the YM/TF (or YM/ES even). This way you sell YM on both legs, buy NQ on the first leg, and buy TF or ES on the second leg. Is this what you were referring to, or am I way off?

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 josh 
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SisyphusStone View Post
Josh, you might find this short vid from Tom Sosnoff of interest. From about 15min in there's an example with MA and V, but the rationale behind AAPL vs QQQ (= 1NQ) is worth considering.

https://www.tastytrade.com/tt/shows/MT/episodes/1337

SS

I really appreciate this link @ SisyphusStone .Coincidentally enough, over the last 36 hours I have watched probably 5 hours of tastytrade videos. I am doing an options cram session this upcoming week, as I think it will be beneficial for spreading as well, since similar strategies are often used in both domains. I know very little about options in general, and it's time for me to stop being lazy and learn, and their videos are very educational, and very much in the realm of practicality versus theoretical. Thanks again!

Here is another episode that is similar. Great stuff, good to watch all the way through:
https://www.tastytrade.com/tt/shows/MT/episodes/1392

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 indiantrader 
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@josh

Thanks for posting the links, the trader anchor Bob is quite entertaining.

He showed mean reversion as the only pairs trading strategy, however most of synthetic stock pairs spreads go on widening without much mean reversion. When one stock outperforms other, there are fundamental reasons for that and to short the fundamentally strong stock and buy the weak stock in the hope of mean reversion can be disastrous.

Here is a pic of IBM vs HPQ over last 3 years and it shows how IBM has outperformed the HPQ, any mean reversion trades would only have hit the stops again and again.

Here is an article by Lex Van Dam criticizing the mean reversion pairs strategy.

Why I won?t teach pair trading to my students - MarketWatch

Mean reversion is suitable for spreads like condors, double butterfly, interexchange spreads, cash-futures spreads etc.

The butterfly on ES/NQ/YM may not be a good idea. Butterfly is more suited for a single product with different expiry months. The only synthetic spreads suitable for butterfly are treasury futures like 5-10-30 years or Scahtz-Bobl-Bund.

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 SisyphusStone 
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josh View Post
I really appreciate this link @ SisyphusStone .Coincidentally enough, over the last 36 hours I have watched probably 5 hours of tastytrade videos. I am doing an options cram session this upcoming week, as I think it will be beneficial for spreading as well, since similar strategies are often used in both domains. I know very little about options in general, and it's time for me to stop being lazy and learn, and their videos are very educational, and very much in the realm of practicality versus theoretical. Thanks again!

Here is another episode that is similar. Great stuff, good to watch all the way through:
https://www.tastytrade.com/tt/shows/MT/episodes/1392

Well well, great minds think alike - or is it small minds seldom differ?!!! Glad the link was of use, Josh and thanks for yours. I too have recently finally got off my butt and begun to seriously get my head around options and like you have been intensively mining the TT archives. I don't think I've come across anything that comes close, in terms of quality and relevance, anywhere.

I made a tentative start with options some months ago with a course by Jonah Ford ( spreadtrader) but he had to abandon it mid-way due to having to have surgery. Anyways, he's about to re-run it starting Oct 5th, so you might be interested since it's only $50 and I felt the first 3 weeks he did alone was value for the money. He's primarily a commodities trader and also has a course on spreads for a bit more, that I've not yet done - I was going to follow on if the options one was worth it.

I also did the $7, one month trial to John Carter's ( Option Trading Strategies | Online Training | SimplerOptions.com) site. I found his approach very interesting and there were aspects to his methodology that I liked a lot. Again, I think you might learn plenty there for $7. He mainly trades weekly equity options to capitalize on the rapid theta decay. He's been on TT a few times too. He uses a squeeze system based on Bolingers, Keltners and Momentum to identify low volatility areas of congestion for trade entries. Not quite my thing as I use Wyckoff/VSA, but both methiods are essentially seeking the same result. He also swears by the fib-based VooDoo lines indicator for support and resistance. Not convinced personally, but if you're interested I can give you the ratios for a simple work-around using any fib indicator, that seems to work just as well. As a non- US resident I can't get access to the TOS platform - some BS from TDAmeritrade about UK/European regulations that prevent them from offering it. Not sure how come I can trade options through my IB platform then!!! IB's options platform is powerful and comprehensive, but, like all things IB, I don't find them very intuitive, or simple to use. The TOS platform on the other hand seems very straightforward and intuitive, though reviews are not so glowing since TDA bought it from Sosnoff - now there's a surprise!

If you're not familiar with Wyckoff I would strongly recommend taking a few hours out to at least familiarize yourself with the broad schematic (https://www.hankpruden.com/MTWyckoffSchematics.pdf) as it works very well for spreads.

Enough! Anyways, a few thoughts and suggestions there that you might find of interest - or any other subsequent reader - and good luck with the pairs/spreads trading and options.

Best

SS

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TheDude
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josh View Post
Thanks for the encouragement and info @TheDude . Do you mean to short the ES-NQ spread as I did here and then buy the NQ-YM? If that's what you mean, it would be doing damn well right now. Russell and Nasdaq have been super strong in the last 2 weeks, relative to the S&P which has been flat to down, and the Dow has just been a dog and has been particularly weak since the 9/18 high.

I thought a fly was usually constructed such that one product was hit twice, and the other two were bought once. So for example, buy the NQ/YM and sell the YM/TF (or YM/ES even). This way you sell YM on both legs, buy NQ on the first leg, and buy TF or ES on the second leg. Is this what you were referring to, or am I way off?

Nope - you've got it. A fly is +1x, -2y, +1z so you can look at it as a spread against a spread with +1x-1y hedged/offset with +1z-1y, or you can just look at it as a fly!I dont know the ratios, but if you're doing say 2 ES against 5 NQ and 3 YM against 2 NQ then your fly will be say 2ES-7NQ-3YM

You could get really crazy and get a double fly with +1p, -3q, +3r, -1s with es, ym, nq and tf.

Generally,the more legs you add, the more tricky execution becomes to get the right price. Charting the structures also becomes quite difficult as in this example you're looking at products across 3 exchanges so getting ohlc data is impossible pretty much - unless you have a front end with an autospreader that will also construct synthetic charts from the autospreader.

Generally, the more 'complicated' the structure, the more rangebound they become, so it ends up simply working bids and offers at support/resistance points. The skill is in getting good prices through the various spreads you are trading in order to get a good price on the overall structure.

Obviously trading costs also need to be considered agaisnt the expected return per trade. Trading this way is about the only time IMO when you can add to losers becsue of the nature of the structure. If it pops out, you can put some more on pretty certain it will revert back to the glorious mean!

I dont trade in this fashion, but I know a few guys who do as a sideline to their main trading strategies. They mostly trade treasuries and energies this way, but maybe index products can be traded too?

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TheDude
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indiantrader View Post
@josh


The butterfly on ES/NQ/YM may not be a good idea. Butterfly is more suited for a single product with different expiry months. The only synthetic spreads suitable for butterfly are treasury futures like 5-10-30 years or Scahtz-Bobl-Bund.

This could be so.

I have no experience of index flys. I just put it out there as food for thought.

Youre right that inter product flys are more common on treasuries, but maybe it could work on index products? Unless we investigate we will never know.... The structure could well be a huge mess!!

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 SisyphusStone 
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TheDude View Post
Nope - you've got it. A fly is +1x, -2y, +1z so you can look at it as a spread against a spread with +1x-1y hedged/offset with +1z-1y, or you can just look at it as a fly!I dont know the ratios, but if you're doing say 2 ES against 5 NQ and 3 YM against 2 NQ then your fly will be say 2ES-7NQ-3YM

You could get really crazy and get a double fly with +1p, -3q, +3r, -1s with es, ym, nq and tf.

I dont trade in this fashion, but I .............

..... think that's very prudent!!

Strewth, just reading through the setup of those B'flies made my head spin. Seems to me thzat you are introducing any number of additional risks just in terms of good executions, not only in laying on the positions, but then exiting too which might well be far more critical. Does this level of 'sophistication' really lead to a genuine edge? Personally, being a simple soul, I try and keep everything as simple as possible - the old 'KISS' principle ie. Keep it Simple Stupid.

SS

"Give me control of a nation's money and I care not who makes the laws."
Mayer Amschel Rothschild (1744 -1812)
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TheDude
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SisyphusStone View Post
..... think that's very prudent!!

Strewth, just reading through the setup of those B'flies made my head spin. Seems to me thzat you are introducing any number of additional risks just in terms of good executions, not only in laying on the positions, but then exiting too which might well be far more critical. Does this level of 'sophistication' really lead to a genuine edge? Personally, being a simple soul, I try and keep everything as simple as possible - the old 'KISS' principle ie. Keep it Simple Stupid.

SS


I agree 100%.

It does however make the illustration of what is possible with spreads and the broader possibilities of the kind of structures can be made.

You also identify the point that a traders job is in execution (not a TA analyst - thats done by TA analysts, not traders!), and spotting good points and understanding the difference bad execution will make. Autospreaders are key to this type of trading. No one will try to manually work more than 2 legs.

As Indiantrader said - these are mostly done in treasury markets where the relationships are more certain and the structures are more definite.

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  #71 (permalink)
 Big Mike 
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@josh,

How did this play out?

Mike

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 WolfieWolf 
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TheDude View Post
I agree 100%.

It does however make the illustration of what is possible with spreads and the broader possibilities of the kind of structures can be made.

You also identify the point that a traders job is in execution (not a TA analyst - thats done by TA analysts, not traders!), and spotting good points and understanding the difference bad execution will make. Autospreaders are key to this type of trading. No one will try to manually work more than 2 legs.

As Indiantrader said - these are mostly done in treasury markets where the relationships are more certain and the structures are more definite.

@TheDude .. hmmm "Dude" from London, you remind me of someone I met in Amsterdam. Walbrook house mean anything to you?

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  #73 (permalink)
 baywolf 
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FWIW I used to trade a portfolio of equity pairs from 2008-2010 when stocks were highly correlated. The pair selection was based on backtests and did much better in the backtests versus real market, even with conservative commissions and slippages added. Still made some good money from the strategy but I've since switched over to futures. Even with HFT liquidity takers, futures exchanges like CME are a much more fair venue vs equity markets.

Here are some screenshots I took of the backtests.








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 josh 
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Big Mike View Post
@josh,

How did this play out?

Mike

@Big Mike, have been super busy with a lot of trading goals, and I have done some options spreads, but I haven't put on any commodity spreads so far. In the coming months I may have a chance to do that but as of yet have not. To what degree I will put on pairs trades in the future depends on a lot of things but I will definitely update the thread here accordingly. Hope you have had a good new year so far!

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Johno1
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TheDude View Post
Sorry, no empirical evidence here - just observations and experience. Ive traded loads of crude spreads where the daily outrights have been stuck in a range, but the spreads have been trending like a MF'er.

The bold highlights seem to answer your question in a way? The nearest thing I could perhaps refer to is the MRCI results I provided a link to. Not ideal though - basically 180 spread trades over the course of 2012 making >$100k trading 1 lots v 180 outright trades making a big fat zilch - suggesting a propensity to trend more? interesting that this seems to suggest that the less risky spreads are returning more than the more risky/volatile outrights, implying that less risk does not necessarily equate to less return at all? Since 1990 (4140 spreads and 4140 outright trades) spreads returned $800,000, outrights a cool $1,000,000 (approx) Although the spreads returned $200k less, I'd rather be trading them as the reduced risk and margin would allow us to blow outrights out of the water assuming we were using the same capital base. Here's the link again: 2012results

I agree 100% with what you say with regards to intraday price and daily price. I was trying to say just this a while back - but not so eloquently as you

Hi Dude,
Thanks for that information, my experience is much the same. Yes, my days of trading outrights are long gone.
Cheers John

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 Farmer George 
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baywolf View Post
FWIW I used to trade a portfolio of equity pairs from 2008-2010 when stocks were highly correlated. The pair selection was based on backtests and did much better in the backtests versus real market, even with conservative commissions and slippages added. Still made some good money from the strategy but I've since switched over to futures. Even with HFT liquidity takers, futures exchanges like CME are a much more fair venue vs equity markets.

Here are some screenshots I took of the backtests.








Are you trading pairs on the futures exchanges? Thanks.

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 baywolf 
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Yes, exchange listed spreads mainly.

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 Farmer George 
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Yes, exchange listed spreads mainly.

Ok thanks for that. Looking to identify brokers in the UK who have pairs trading - if indeed such instruments do exist!

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i have been spread trading futures for 10 years+. It has got harder but there is still some money to be made...

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gears
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I have done some options spreads, but I haven't put on any commodity spreads so far. In the coming months I may have a chance to do that but as of yet have not. To what degree I will put on pairs trades in the future depends on a lot of things but I will definitely update the thread here accordingly.

Wondering how things have fared since January 2014?

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 TickedOff 
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Is there anywhere I can view spread charts with candlesticks? I am interested in looking at the price action of spreads and seeing if there's anything to it.

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 shuglu 
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Is this useful?


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 shzhning 
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here're 2 charts from cgq qtrader on EP(ES) reverse calendar spread and NOB spread, just the opposite each other

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 TickedOff 
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shzhning View Post
here're 2 charts from cgq qtrader on EP(ES) reverse calendar spread and NOB spread, just the opposite each other

the one on the left looks relatively "normal", exceptionally clean trend stands out and the one on the right is not what I have seen in any product and doesnt look readable but looks like you would just apply a mean reversion strategy. Its hard to make out any clear levels and some of the breaks from the mean look quite erratic, I would have a difficult time figuring out when to exit when a position goes against me.

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 jodistrict 
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TickedOff View Post
the one on the left looks relatively "normal", exceptionally clean trend stands out and the one on the right is not what I have seen in any product and doesnt look readable but looks like you would just apply a mean reversion strategy. Its hard to make out any clear levels and some of the breaks from the mean look quite erratic, I would have a difficult time figuring out when to exit when a position goes against me.

The second chart is trading a range which is what you want for pairs trading. Since its a range and you expect mean reversion, a pairs trader would scale in his capital when it goes against him. An ultimate stop could be placed at some multiple of standard deviations from the mean.

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 datahogg 
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kevinkdog View Post
I have been swing trading calendar spreads for a number of years. I trade most of the ags, softs, energies, etc.

Yes, you do have to get direction right for the trade to work.

You can forget about arbing spreads - people much smarter and faster have this locked down.

You have to be really careful when looking at any prices unless 1) they are settlement prices or 2) they are exchange traded spread prices. You can't just throw up a candlestick chart of Nov Beans minus July Beans and expect to get something meaningful. This is because last trade price times will be different. You could accurately chart the exchange quoted spread on Nov/July Beans.

Many times spreads tend to trend more smoothly than the outrights.

Ag spreads many times follow seasonal patterns. Summer 2012 was an exception to that, as I found out.

Many pros in Treasuries are spreading. I know a mid size hedge fund that always and only spreads.

Margins are greatly reduced for spreads, so you can probably trade more pairs, or greater size, than an outright account.

You can easily lose money. "How I Lost 1 Million Dollars..." is a great book on a Soybean spreader who got crushed (no pun intended).

You will pay double commissions for each trade.

Also, any kind of backtesting is a TON harder with spreads, even if you have access to the exchange spread feed (Tradestation, for example, in their infinite wisdom, does not offer the exchange spread feed in their data). You can't really do continuous contracts. I've written giant custom macro spreadsheets to perform some of this backtesting. It is a pain.


One thing to think about: spread trading might have opportunity because so few people take the time to look at it, and learn about it.

Are you spread trading presently? Did the August sell off have a large effect on your spreads?

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 kevinkdog   is a Vendor
 
 
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Are you spread trading presently? Did the August sell off have a large effect on your spreads?

Not really. Lost a little bit in spread trading in August, but made it back (and then some) in September. Slightly down overall in 2015 for spread trading.

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 Kruger 
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kevinkdog View Post
Not really. Lost a little bit in spread trading in August, but made it back (and then some) in September. Slightly down overall in 2015 for spread trading.

I'm in a similar situation. I eventually moved into profit this month and watching the May 16 Soybean-Corn spread closely to make sure it doesn't tank on me.

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 ElChacal 
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Does anybody here trade currency pairs based on bond/commodity spreads? I have found some interesting correlations but no "holy grail" yet (and apologies to the non-believers for my ridiculous attempt).

I was wondering if anybody here with actual experience could provide an insight. I don't have a great strategy other than ES and I really need to diversify!!

For instance, (Gilt - ^TNX) and 6B would make some sense to me but still trying to find the right conversion factors between Gilt and TNX and 6B...

I have found other relationships but getting it on a strategy that works seems to be the challenge. Mean reversion is apparently not the way to go, maybe a breakout of +/- 1 Std or some conversion with % change of the variables, a good de-trender dunno...

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 datahogg 
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Of these 2 spread data sources (Moore Research Center vs SeasonAlgo) which is the best in terms of
results and data?

Thanks in advance.

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 Kruger 
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Kruger View Post
I'm in a similar situation. I eventually moved into profit this month and watching the May 16 Soybean-Corn spread closely to make sure it doesn't tank on me.

Just an update on this. I made a neat profit on the Soybean-Corn spread so I could end of the month on a positive and also pushed the year to date into profit.
Currently in on Lean Hogs Jun-Feb16 spread.

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Kruger View Post
Just an update on this. I made a neat profit on the Soybean-Corn spread so I could end of the month on a positive and also pushed the year to date into profit.
Currently in on Lean Hogs Jun-Feb16 spread.

Exchange traded spread or synthetic?

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 Kruger 
Cape Town South Africa
 
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DionysusToast View Post
Exchange traded spread or synthetic?

Seasonal Commodities :CME - not familiar with synthetic

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 xiaosi 
Brisbane, Queensland, Australia
 
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Kruger View Post
Seasonal Commodities :CME - not familiar with synthetic

Synthetic is when you construct the spread your self by simply long one leg, short one leg of a spread, could be calendar intra-market or inter-market. For example, many of the crack spreads are exchange traded now, where as if i wanted to construct a spread from the NK and the ES, i would have to do this by legging into them manually.

XS

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 datahogg 
Knoxville Tennessee USA
 
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This is just an idea and a question. The MACD indicator calculates the difference between typically the 12 EMA and the
24 EMA and then uses a 9 EMA to smooth the difference. (Hope I have this correct.) Is it possible to modify the
MACD to subtract say a (Jan CL 5 unit futures moving average) from a (Mar CL 5 unit futures moving average) (Mar CL 5 unit futures moving average - Jan CL 5 unit futures moving average ) and use a smoothing moving average (probably small) to produce an indicator? (The number 5 is only used as an example.) So instead of the MACD charting a single index or other, it would chart the spread differential (using 2 futures moving averages )? This might produce a better spread chart?

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jumpingfella
Heidelberg, Germany
 
 
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Does anybody trade /ES calendar? /ESH7-/ESM7 ? I'm wondering if it's possible to get any fills on the edges of the range

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 datahogg 
Knoxville Tennessee USA
 
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jumpingfella View Post
Does anybody trade /ES calendar? /ESH7-/ESM7 ? I'm wondering if it's possible to get any fills on the edges of the range

These 2 are highly correlated. It would be difficult to obtain much difference between the two, but I have never
traded them. I have traded successfully the spread (ES-YM) . At IB the margin for this is aout 2k.

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 SMCJB 
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The ES spread is theoretically just a function of interest rates and dividends and as such should be arb-able. Hence it doesn't move very much. Also while ES itself trades in quarter points/$12.50 ticks the spread trades in twentieth's or just $2.50/tic and it's one tick wide, hundred's up. So not saying it can't be done, but I think it would be very difficult. Also front spread is basically the only thing that trades.

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jumpingfella
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ok, what about the following: /ESH7-/ESM7+/TFM7-/TFH7

this lowers margin requirements, and it seems to stay in the range.

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 datahogg 
Knoxville Tennessee USA
 
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kevinkdog View Post
Note that if you use continuous backadjusted contracts, using ratios will be incorrect for all but the current contract. It might not be wrong by much, but it will be wrong.

That statement also applies to any trading system that uses multiplication or division of the continuous, backadjusted price.

Kevinkdog. If you were to plot a ratio of a 5 minute EMA (exponential average) of ES and a 5 minute EMA of NQ,
would this be a reliable spread chart??

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