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Forex Elliott Wave

How to Use ETFs to Create Spreads

Exchange-Traded Funds, or better known as ETFs, are investment instruments that are traded in a centralized market. In this educational article, we will see how we can use them to create negotiating opportunities.

Exploring Markets and Diversification

In financial markets, there are virtually unlimited possibilities for investment. Decisions such as what to buy? What to sell? As well as the geographical region, level of risk, liquidity of the market or assets, expected profitability, among other aspects, are factors that an investor can face when planning his future investment.

Use of Intermarket Spreads

In simple words, a spread is a strategy on which the investor buys one market and sells another market simultaneously. For example, in the currency market, an investor could buy a contract of €100,000 and simultaneously sell a 100,000 euro on pounds sterling. In other words, this trade is equivalent to go long in the EUR/GBP spread.

Creating a Spread with ETFs

We can create different spreads according to the market in which we are interested in investing. To this end, the decision criteria will be those ETFs with higher liquidity. The following tables represent ETFs that are associated with commodities, particularly Gold and Silver.

Table 1 – ETFs Based on Gold

Table 2 – ETFs Based on Silver

From tables 1 and 2, we see that ETFs GLD and SLV record the largest size in each group. Consequently, they will be used for the construction of the GLD/SLV spread.

The GLD/SLV spread in its daily chart shows both precious metals developing a corrective structure as a B wave. Therefore, the Gold/Silver spread could see a new low. In other words, we expect a decline in GLD and an upside in SLV.

The following example shows the spread between SPY and QQQ in its daily chart. The ETF SPY is characterized by replicating the S&P 500 index, while QQQ replicates the NASDAQ 100 index.

In the spread graph SPY/QQQ, we detect that the price is developing an Ending Diagonal structure in a bearish cycle. Also, although QQQ continues to push downwards in front of the SPY, it should be noted that this pattern is an exhaustion formation. Thus, it is likely that these markets reverse soon. In this case, the positioning strategy would be a long position in SPY and another short position in QQQ.

Conclusion

After the analysis made here, you may see that everything traded, including pairs, can be considered as spread bets between an asset the underlying payment method. It is just that, considering the relative stability of fiat money it makes more sense to use the term spread when exchanging two volatile assets, as one of the main objectives of spread bets is to tame the overall market volatility since the investor is selling and buying volatility at the same time.

According to what here is exposed, the creation of spreads can help explore the strength/ weakness situation between markets. Likewise, the exercise could help to make decisions on which assets to choose. It should be emphasized that before entering a market, the  spread’s price action must confirm the movement that is predicted.

Finally, this type of analysis can be extended to the futures market between futures contracts with different or similar expirations. This kind of analysis can also be applied in the stocks market, bonds, etc.

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Forex Course

6. Different Ways Of Trading The Forex Market

Introduction

Forex is a market to trade foreign currencies. It is traded 24 hours electronically over-the-counter, meaning the transactions are performed over the networks around the world. One way to trade the forex market is for one party to buy a currency, and the other to sell it. This method is referred to as spot forex trading. Apart from this, there are other ways to trade the Forex market. And in this lesson, we shall discuss these different ways.

Forex market and its types

If we were to consider the primary forex market asset types, we could find four. They are:

Spot Forex Market

Currency Futures

Currency Options

Currency Exchange-traded funds

Now, let us explain the working of each one of them in detail.

Spot Forex Market

As discussed, in the spot forex market, currencies are bought and sold for a short period of time, based on the current market price (CMP). The prices in this market are settled in cash, on the spot, bases on CMP. Hence, the spot market is also called a ‘cash market’ and ‘physical market.’ The settlement of orders in the spot market takes two days, while in the futures market, it takes much longer.

Spot trading is the most popular form of trading where the majority of the retail traders trade on. There is great liquidity in this market, and brokers even offer tight spreads on them. Apart from retail traders, other participants in this market include commercial banks, central banks, arbitrageurs, and speculators.

Currency futures market

In the currency futures market, the buyer buys a contract of one currency by paying another currency. While the seller of the contract holds the opposite obligation. And this obligation is due on the expiration date of the future. The ratio of the currencies is settled in advance between both the parties (the time when the contract is made). The parties make a profit or a loss depending on the difference between the real effective price on the date of expiry and the settled price.

Currency Options

A currency option is a type of options contract that gives the buyer the right, but not the obligation, to buy or sell a currency pair at a given price before a set time of expiry. To get this right, the holder of the option pays a premium to the seller who is known as an option seller.

There are two types of currency options, ‘Call option’ and ‘Put option.’ A call option gives the buyer the right to buy a currency pair at the strike price before the expiry date. A put option gives a buyer the right to sell a currency pair at the strike price before the expiry date. Currency options are a popular way of protecting against loss.

Since the options are a bit complex, let’s understand them with an example. If you believe that the price of the Euro will rise against the US dollar, you can buy a currency call with a strike price of 1.31000 and expiry at the end of the month. If the price of EUR/USD is below 1.31000 on the expiration day, the option expires worthless, and you would lose the premium paid. On the other hand, if EUR/USD increases to 1.50000, you can exercise the option and buy the currency for 1.31000 (At strike price). By doing this, you have generated high returns on your investment by using options.

Currency exchange-traded funds

Back then, Exchange-traded funds (ETFs) were only available for the stock market. But in the present, ETFs have expanded to the Forex market as well.

A currency ETF is a fund that clubs a single or typically a bunch of currency pairs. These funds are managed by financial institutions and are offered to the public for purchase on an exchange board. Hence, one can trade ETFs just like any share on the stock market.

These are the four primary ways of trading the Forex market. Now take the quick quiz below to know if you have understood the above concepts.

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