There are several ways how to reduce risk in trading futures. Very popular are options, but I would recommend to consider futures spreads, also known as commodity spreads. Spreads have many advantages and we do not need to have to pay for premium as it is in options.
Why to trade spreads
- Suitable for beginners with small account.
- Fundamentals do not have such an impact as to the outright futures.
- Trading is simple and less time consuming. It takes only few hours every two – three weeks to prepare potential trades and then just couple of minutes daily to control the positions.
- Traders can achieve high percentage of winning trades, 80% is not unusual.
What is spread trading
Spread means simultaneously buying one contract and selling another contract on the same or related asset. The profit is made from the change in price difference between two contracts.
What is spread trading and how to create a spread from two outright futures contracts is shown in the video.
Watch on YouTube: What is Futures Spread Trading
There are several applications on the market (paid or free) where trader can easily create spread charts. Applications also provide analytical functions in order to find best spreads to trade.
As you can see in the video the CLF 17 and CLK 17 charts are very similar. In case some fundamental factor occurs with strong impact in Crude Oil both outright futures can significantly move in whatever direction, but due to high correlation between them there will not be such an impact to spread. Spreads are usually less volatile and trading them is less risky. Trader can compose spread from different contract months or different outright futures and create chart up to his risk preference.
Hence the spreads are generally less volatile than outright futures, the exchanges know that and lower the margin requirements. Low margins allow to trade multiple contracts.
Commodities have tendencies to move in a given patterns in particular times of the year. Knowing of seasonality patterns help trader with trading such an opportunity.
And how to trade them? See the description of simple spread strategy.