Joe Ross' Spread Scan Newsletter

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Spread Scan Issue: December 31, 2008 - Volume 227

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Otherwise, welcome to this week’s issue of the Joe Ross Spread Trading Newsletter.

The Spread Scan weekly newsletter is designed to assist you in becoming a better, more complete trader by showing you, within the context of the markets, how to trade spreads.

In this newsletter you will see applications of spreading in the futures and commodity markets. Spreads are applicable to all futures markets including currencies, commodities, financial instruments, and stock indexes. It is even possible to trade spreads in the all-electronic intraday market using day trading techniques.

Spreads are based on seasonality, correlation, backwardation, chart patterns, and simple observation. Spreads follow the Law of Charts™ and can be implemented using the Traders Trick™ entry.

In each issue of Spread Scan, you will find an upcoming spread trade for your consideration in the following week. You will also find a review of an existing or closed spread so you can see and learn how spread trades are managed.

Spreads offer you the most efficient use of your margin account of any other way to trade. Many traders find they like them so much that spreading becomes their primary way of trading.

Each week we present spread trading examples and opportunities to help you become a more professional spread trader, and we provide you with helpful content of interest to traders:

THANK YOU, SPREAD SCAN READERS

A Personal Note from Joe Ross to our many subscribers:

2008 was an excellent year for spread trading, as are most years. In reviewing all of the trades made during the year, we find that there have been periods where there were so many spread trades that it was difficult to choose the best ones. It seemed that all of them were the “best” ones. We were fortunate in the ones that were chosen.

As is typical in any trading year, there were periods in which we have to exercise patience to wait for good spread trades. But patience had its reward, and overall we came out smelling like a rose.

We took a poll of our spread trading subscribers to Traders Notebook. We were very pleased to see that 82% of them were very happy with the result of their trading.

Spreads still offer one of the most cost-effective ways to trade. With margins so high in the outrights, the spreads were spectacular in offering the best and most efficient use of capital.

The risk factor in spreads can range from very low risk to relatively high risk. Fortunately for spread traders, there have been plenty of all kinds.

We continue to see that spread trading is one of the best ways to ease into trading the futures markets. With low costs and low risk, spreads are truly a thinking trader’s way to trade.

We thank Andy Jordan for doing an outstanding job of demonstrating, week-after-week, the examples of winning spread trades which were published in our free weekly Spread Scan newsletter.

Wishing you all the best in 2009,

Joe Ross & the Team at Trading Educators

Andy Jordan's Spread Scan Example

Spread Scan issue # 226 and issue # 227 do not include Andy's Spread Scan Example or previous Trades. Trading Educators is on break between December 15, 2008 and January 4, 2008. We strongly advise all traders to refrain from trading near holidays - volume is thin, and those participating have nothing better to do than fish for stops!

Next Spread Scan with commentary and Spread Examples will be sent out to all subscribers January 7, 2008.

Previous Trades:

Andy Jordan's Trading Bites

The Law of Large Numbers™ (LLN)

by Andy Jordan

(Some basic mathematics stuff a trader should know – but don’t get discouraged if the first part of this lesson seems very complicated. It all becomes crystal clear later on.)

The law of large numbers (LLN) is a theorem in probability that describes the long-term stability of the mean of a random variable. Given a random variable with a finite expected value, if its values are repeatedly sampled, as the number of these observations increases, their mean will tend to approach and stay close to the expected value.

The LLN can easily be illustrated using the rolls of a die. That is, outcomes of a multinomial distribution in which the numbers 1, 2, 3, 4, 5, and 6 are equally likely to be chosen. The population mean (or "expected value") of the outcomes is:

(1 + 2 + 3 + 4 + 5 + 6) / 6 = 3.5.

The graph below plots the results of an experiment of rolls of a die. In this experiment we see that the average of die rolls deviates wildly at first. As predicted by LLN, the average stabilizes around the expected value of 3.5 as the number of observations becomes larger.

The LLN is important because it "guarantees" stable long-term results for random events. For example, while a casino may lose money in a single spin of the American roulette wheel, it will almost certainly gain very close to 5.3% of all gambled money over thousands of spins. Any winning streak by a player will eventually be overcome by the parameters of the game. It is important to remember that the LLN only applies (as the name indicates) when a large number of observations are considered. There is no principle that a small number of observations will converge to the expected value, or that a streak of one value will immediately be "balanced" by the others.

So, why is this important for a trader?

It is important to understand that we all trade based on probabilities. All we really know is that we can make money with trading only in the long run. We have no idea of what will happen with our next trade, or with the next ten trades!

Let’s have a look at the following chart.

The 5 equity curves from above are based on a trading method with the following statistical values:

Winning Percentage is 20%, and the winners are 5 times bigger then the losers.

As we can see on the chart above, all equity curves are showing a profit in the long run. But we would have to go through different emotional periods while trading on the same probabilities. The guy trading the red line would get mad right in the beginning. He would start losing in the beginning, but do well later. The green guy would get even more frustrated. After trading for almost nothing for the first half, the equity goes down a lot before moving up nicely at end of the year.

As you can see, both would end the year with almost the same result. But the way they got there was completely different.

Once again, all curves above are based and calculated at random using the same parameters.

What does this mean for us?

This means we have to make sure we stay in the water long enough for the big wave to take us into the profit zone. We have no idea when this will happen, at the beginning of the year or at the end.

Here is what we have to do:

We need a solid money management technique. There is no way to get around losing periods, and we have to make sure we survive such times.

We have to understand how important it is to look at our results in the long run. Everything that happens in a shorter time period has no meaning.

We need a solid system we can follow. Otherwise we will have problems following the system in bad times (many, many traders don’t understand this point and they just jump from one method to the next, losing all the money they have).

We have to make sure we let the big winning trades run, and cash in as much as we can on such trades.

We have to stay “in the water.” We just don’t know if the next trade will be a losing trade, a winning trade, or one of the really “big fish”.

Trading is not about what happens on a single trade. What really counts is if your trading is based on a solid method, and that you understand good money management. If so, the large numbers of tries will make sure you are profitable in the long run.

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Joe's philosophy for helping traders is:

Educator for Spread Trading and
Editor of Traders Notebook & Spread Scan

"Teach our students the truth in trading — teach them how to trade. Give them a way to earn while they learn, realizing that it takes time to develop a successful trader."

Joe sets forth the mission of Trading Educators as follows: