convergence defined as a case When two or more things come close to each other. It comes from the term convergence and is applied in some of the most important industries in the world such as the financial market.
We often tend to think of it as the opposite difference, but even this term is something that traders need to know. In this article we will look at How to trade affinity in the financial market.
What is the convergence trading strategy?
Convergence is a business approach Commonly used in arbitrage. He. She Includes buying and selling similar assets In the market At the same time. In most cases, the convergence strategy is used by large hedge funds and investment firms.
In most casesConvergence trading strategy It includes two types of assets: spot and futures contracts. The spot price refers to the current price of a financial asset such as stocks and commodities such as gold and crude oil. On the other hand, the price of a futures contract is what investors have the right to sell at but not the obligation to sell at.
Related “ Stocks vs futures trading
The chart below shows the various prices of West Texas Intermediate (WTI) in the futures market. In October 2022, the spot was trading at $85.51. Therefore, futures traders seem to believe that the price of WTI will decrease in the future.
convergence It is often seen as a strategy This is it Not as dangerous as other methods to trade. However, in most cases, it usually means that it is a dealer needs a contract two Parking for a long time.
Affinity vs. Difference
The Reverse convergence is the difference. bifurcation It occurs when two similar assets move in different directions.
Another common approach to difference is based on Technologies. It is a case where A financial asset is moving up while oscillators are moving in the opposite direction.
For example, the price of an asset may rise while the Relative Strength Index (RSI) or MACD is moving in the opposite direction. When this happens, there is usually a file There is a good chance that the price will eventually go down.
Convergence vs Arbitrage
Convergence trading strategy is a type of arbitrage strategy. for beginners, Arbitrage It is a commercial approach Includes the purchase and sale of two financial assets At the same time And then take advantage of the difference.
For example, the Vanguard Tech Index and the Invesco QQQ are always moving in the same direction because they track the same index. As such, a trader can buy a large amount of QQQ and then sell a smaller amount of the Vanguard Index.
In this case, if the trade is successful, the profit will be the difference between the two financial assets.
How does the convergence trading strategy work?
To understand the concept of convergence, it is important to Learn how the futures market and spot market work.
As mentioned above, the Spot price from an asset What are you selling at the moment?. When you buy a spot stock with a broker like Robinhood or Schwab, you are simply buying the current price. As such, if Apple shares are trading at $100, that is the price that sellers are willing to buy.
Another approach is to use the options market To buy or sell Apple shares depending on where you expect them to go.
In this case, You can either put the call optionWhich gives you the right to buy shares at a specified price by the expiration date. Alternatively, you can put a file put a choicewhich gives you the right to sell shares at a specified price by the expiration date.
Therefore, a convergence trading strategy is a situation where you open two positions in the spot and futures market.
A good example of convergence trading is where You buy one asset forward and then sell the same asset at a higher price.
Hope is that Spot and futures prices will converge Because it is approaching the expiration date of the futures contract. This happens because the market will not allow the same asset to trade at different prices at the same time.
Examples of popular convergence trades
Convergence trades can occur across all financial assets but they are Most common in stocks, bonds, and commodities.
A good example of convergence trading In the gold market. A good example of this is if gold is trading at $1000 and a futures contract is trading at $1200. In this case, the trader can decide to buy gold at the spot price and then sell the future contract.
The hope is that eventually the two prices will converge to the expiration period, which will make the trader $200.
In the example above, we see that the West Texas Intermediate was trading at $85.51 in October while the February futures contract was at $82.21. In this case, the trader can sell the spot price and buy the forward contract.
Another example is in the bond market. In it, the trader can buy junk bonds, which are very risky, and then buy short treasury bonds.
Treasuries in a country like the United States are viewed as a very safe asset.
Convergence Pattern Risks
There are many risks to trading the convergence model. First, there The risk that a potential rapprochement may take too long is happening. A lot can happen while you wait for the situation to happen.
Second, sometimes, due to volatility In the market The expected convergence may fail is happening. Finally, convergence tends to have an extension negative deviation In terms of returns.
So if you’re wondering.. no, cConvergence is not a good tool for day traders Because it takes a lot of time and does not allow you to take advantage of fluctuations.
Summary
Convergence is often one of the most important strategies Used by directional hedge funds and traders. In this article, we looked at how this approach works and outlined some of the best strategies that traders use to take advantage of it.
Useful external resources
- Convergence of trade, arbitrage, and systemic risk in the United States. Bank of France