Below is shown the first and very simple example of a spread chart, to little by little catch the interest. This example is important to understand the mechanism of a spread and to “digest” this theory. It is not posted with the intention to operate with it tomorrow.

This case tries to clarify the concept of applying a certain factor to each underlying to make the spread.

This first example it shows a spread between one contract of the DAX and four contracts of the EUROSTOXX50. This is an attempt that the size value of each lot is as similar as possible.  When trading we will buy one DAX contract and sell four contracts for the Eurostoxx to go long the chart and vice versa for the short side.

To see the correlation between the two lots, the easiest and most clarifying way is to create a chart that represents the difference in Euros between the nominal value of 1 Dax contract and 4 Eurostoxx contracts, which was 23,859 euros when drawing the chart:

To achieve this difference in euros the factor to apply to the DAX is 25, which corresponds to the 25 euros that costs each point of a contract of the Dax. The factor for the Eurostoxx will be 40, which corresponds to multiplying the 4 contracts by 10 euros of each point of an Eurostoxx contract. 
 

Without going too deeply into this it immediately presents several important points:

1. The chart is about to be consolidating the second shoulder of a head and shoulders pattern. If it is finally formed and the neckline broken, the just started downtrend can be followed by selling one contract of the DAX and buying 4 contracts of the EUROSTOXX50. Traders that can assume more risk could enter it now believing that this pattern can occur.

2. There is a risk difficult to control that is assumed in any market when there is a strong gap to the downside, these losses can not be controlled before the opening of the market because a stop loss order can not be placed. Operating in this type of spread that risk is virtually zero, it is even possible to see by looking at the two charts individually that in some days of big gaps that could turn into heavy losses, trading this spread those losses become profits.

3. There is no correlation between this chart and the trend of the European equity markets even if buying or selling the both indexes themselves, which turns this into a perfect way to diversify the portfolio. Logically when combining this spread with other financial instruments such as interest rate futures, commodities, etc.., the diversification is absolutely perfect.

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