Financial Spread Trading For Beginners
In this article, I want to show what factors to take into account when making a spread trading strategy in the financial markets. Such a strategy should be custom-designed for each person! After all, would you wear clothes made for another person? So it is with trading strategies.
Profit potential in the financial markets is huge – this is its main attraction! As an example, if you had sold the FTSE short in April 2010 and taken profits 1,000 points lower in June, a £ 5 down bet would have produced a profit of £ 5,000 on a margin (deposit) of only £ 500 or so – a 10: 1 home run.
But first, why do we trade the financial markets and what is actually traded? We are all familiar with the Stock Markets, Gold, Crude Oil, Currencies. Take just the Stock Markets – there are many types of participants. There are the big institutions, such as pension funds, mutual funds / unit trusts, hedge funds, and there are private investors, some with long-term horizons, and some with short-term capital-gain interests. We are concerned with the latter here, as these are called traders (that's us).
WHAT IS TRADED IN THE FINANCIAL MARKETS?
What is actually traded and what or who decides on market prices? My interest is in trading the main stock indices, such as the FTSE, the Dow Jones Industrials, the S & P 500, and the NASDAQ. These are all indexes of a basket of company shares averaged in some way. They reflect the general trends in the market, up or down. They are all derivatives.
As a trader, who is someone interested in buying and selling for a profit, and not at all interested in taking possession for any other reason, we want to discover methods which can identify when to buy and when to sell. That is where a simple, semi-mechanical method using technical analysis is necessary, together with a sound money-management scheme.
WHAT OR WHO DETERMINES MARKET PRICES?
What does move market prices? All public markets are what we call 'auction' markets where prices are set by the buying bids and selling offers of the various participants. Have you ever been to a live auction at an auction house? Sometimes, when an object comes up, there is a group of two bidders, both desperate to own that object. The bids ratchet up and up – and up to reach what many would say is a very high price. Now imagine the auction if those two bidders had played golf instead. Of course, the price achieved would have been far lower – and for the very same object!
So what was the true market price for that object? Of course, the concept is meaningless. The market is what the market is. This shows that market prices are determined by emotion, rather than rationality. This explains the various bubbles in financial markets we have seen recently. As traders, we can take advantage of this! Traders love bubbles both in the inflating and the deflating phases.
WHAT STRATEGY FOR YOU?
If you are reliably starting out as a spread trader, you need to determine what type of personality you are (I have explained this in a companion article). You need to match your chosen trading time-frame with your personality type.
If you like staying with a well thought-out trade for weeks and months, then you will be looking primarily at weekly and daily charts and using Elliott Wave and Fibonacci analysis methods (again, described in a companion article). For your money-management plan, you will be placing protective stops somewhat far away from your entry price, but always well within your estimated maximum loss.
If you like short-term trading, you will be looking at daily and 60-min, 30-min, and even 10-min charts in real time. It is almost a full-time commitment. But with expert advice at hand, it can be very profitable