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5 Tips for Choosing a Spread of Stocks

Would you like to invest in the stock market and be safe from bearish trends? There are strategies using options, but this time, I'll explain a trading strategy about spreads with stocks.

Let us start with the basics. A spread is formed when buying shares of a company, and simultaneously selling shares of another company. Profit will be generated in the trade in either of these two options:

1- The shares purchased rise more than the shares sold

2- The shares bought fall less than the shares sold

Obviously, there is a loss either opposing possibility occurs.

These simple tips will help you find spreads in shares with the best guarantees of success:

Tip 1: match the nominal bought and sold. That is, the amount for the purchase must equal the amount of the sale. This adjustment will be made to the number of shares of each company that we will buy and sell.

We will check it better with an example. We can create the spread between General Motors and Ford shares. At this time, the value of shares of General Motors (GM) is $ 32.87 and Ford (F) is $ 15.78. If you buy 100 shares of GM and sell 100 shares of F, we would have an unbalanced spread.

In our example, the correct ratio is 1 share of GM for every 2 shares of F. The resulting chart would be this:

Tip 2: select stocks in the same sector and country. We are looking for a pair of actions that move as a well-matched couple dancing. We want your spread or difference fluctuate within a range, with well defined ceilings and floors.

It will be easier to achieve this condition if we choose actions in the same sector and belonging to the same country. Thus, they will move in the same macro stage.

An example of spread that meets this feature is Bristol Myers Squibb Co - Merck & Co. (BMY-MRK).

It is well appreciated how it moves in a defined range. Right now we have to study a short entry in the spread.

Tip 3: the spread has a floor or a ceiling that has worked on several occasions. To illustrate this point I will use the spread SAN - BBVA

To make this spread between the two big Spanish banks BBVA and SAN, I have posted 142 shares and 100 shares SAN BBVA. Thus I reach an equilibrium point or ground near 0. In this spread, it is much more reliable to search a long position near the floor.

Tip 4: check the fundamentals of the two companies. If we want to operate a range situation, we are not interested in any of the stocks is going through a delicate situation. It is needless to perform a complete analysis of the companies´ accounts. It will work a comparative of key data.

I use the basic snapshot of Finviz including the recommendations of analysts and the latest relevant news. If there is something wrong with any of the stocks, we will be able to detect it.

Tip 5: always use stop loss! Spreads formed with stocks have a high probability chance of moving within a range, but the range can quit at any given time and, what is worse, the spread could never come back to the range. The use of stop loss is mandatory in this strategy.

I conclude this mini-guide to choosing spreads shares with a very interesting tool:

With this US stock market tool, we can determine what stocks are more correlated with a chosen share. For example, with GM, we get the following chart:

The most correlated stock with GM, in the last 60 days has been Ford.

Once we have pairs of actions with a strong correlation, we can study the graphs of their spreads to select operations.

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