Pair Trading How Can It Be Done ..

[Grey1]

Would you like to see, your position be safer than riskier ?
Would it feel great if no matter what happened to market, your position took less hammering ?
Would you like to have a cuppa and be relaxed about your trades than continuous nerve racking analysis of market direction ?

If you are still interested , then pair trading is for you ... Institutions have been using this technique for years but due to their huge position they can 't get in or out fast enough without traders like myself not seeing them ..


Get out of the bad habit of momentum trading .. it does not pay ..

market gonna getch ya

I will expand later on various simple Pair trading techniques..

 

[Grey1]

Which one of the following is correct ?

A) A trader is a person who makes lots of money ,, he is prepared to accept a lot of risk too

B) A trader is a person who does not make lots of money .. There again he does not take lots of risk either

c) A trader is a person who makes more money than B but takes less risk than B..


Trader A is a gambler .. He will soon be out

Trader B is a gambler. TOO. just a coward and scared of taking a lot of risk .. however he is still a gambler.

Trader C is a True Trader..

In classical finance we are not interested in HIGH RETURNS OR LOW RETURNS ONLY .. WE ARE INTRESTED IN HIGH RETURNS GENERTAED AS A RESULT OF TOLERATING LOWER RISK .


The above simple explanation often refers as RISK ADJUSTED RETURN..

I will expand more later .. I will get into new work and research done by myself on pair trading and its application to day Trading .. I am not interested in NON working , time wasting systems.. I really am not.. Hope fully by the end of this Thread you all can pick stocks or Indices to hedge against each other for more relaxing trading day ..


PS:_ we will post intra_day pair trades in real time for you to watch its performance LIVEEEEEEEEEEEEEEEEE
Regards

 

[Niall]

Do you generally only intra day trade pairs Grey? I am very interested in learning more about all aspects of pair trading, altho only swing trading pairs for now.

I note that you have said that the various correlation methods are less reliable within an intra day time frame, for obvious reasons, and you are using the vwap thing (which I have yet to read up on much at all) and other methods for the intraday stuff? But are you also still doing any swing pairs? If not is it because you concluded there were significant advantages to the faster returns of the intraday?

Niall

 

[Grey1]

Hi

The methodology I am using is for intra day .. Can not see why it can not be applied to longer time frame .. The only problem I am concerned about is the over night news affecting the whole analysis.. I will use other techniques which I will explain all in details with example within next few weeks..

regards

 

[Grey1]

Niall,
Just realised that I have not addressed one of your questions..

Correlation analysis is theoretically a sound concept but it heavily relies on past performance.. Well we all know if future resembeld past to a high degree then life would be a lot easier for traders, as a result I have been nervous in preaching this methodology to my fellow traders because I am a paractical guy and like to see performance than a great mathematical concepts.

I think once i have got to the end of my VWAPbased pair tradinging methodologies you wont give a second look at any other from of analysis.

Regards

 

[Grey1]

Pair trading .. continuation

The objective of pair trading is to reduce risk .. that is all.. There are many many ways of reducing risk .. These have been highlighted in academic literature for years .. Pair Trading is a form of market neutral strategy which deals with taking a simultaneous positions one short the other long to reduce the effect of the market direction on the over all position ..

Can we eliminate the risk all together ? NO .. There are some practical as well as theoretical reasons where traders have no choice except to put up with the risk . ( I will discuss that under a new thread Called systematic/non Systematic risk )

I will expand later on

 

[Grey1]

The subject of pair trading has been around for many years.. The whole idea was to use correlation analysis techniques to exploit what might be an out of character of a stock behaviour and capitalise on it..

Example..

AMZN and YHOO nearly always shadow each other .. How ever if for some reason these two stocks divert from each other then one could assume this as being a temporarily behaviour and the un_natural spread between these tow stocks should disappear soon and they continue to shadow each other again .. Same with BT and VOD and DELL AND INTC and so on .. This is often referred as spread trading.. If you want to know about Pair trading based on Correlation analysis, then do a google search and you get a wealth of info..

There are other models for pair trading which is not based on correlation but they are more for longer time frames and nit suitable for day trading..


The problem with correlation analysis is that it relies heavily on past performance and it becomes sort of useless to trade the market based on yesterday's news or behaviour > . let me to make this more clear for you .

We know the chance of head /Tail is 50/50 but your first toss up might be 4 heads .. This is because the 50/50 out come is a result of millions of runs and not a few sample.. Same with Pair trading , there might be a very strong evidence of correlation between YHOO and AMZN but it might not perform next day as one day is too small of a sample for our historical correlation to have much influence on the day we are trading ..

SO Where do we go from here?

WEll, we have to have a methodology which uses the same day's indicators such as HIGH,LOW,VWAP,SUPPORT,RESISTANCE to select the pair candidates..


I will expand later on how VWAP analysis can be used to develop a model for stock selection.. If you are the lucky owner of TS then I will also give you the complete code for pair trading .. All automated.. All you would get is an Alarm..

 

[Trader333]

Grey1,

Sounds even better than what I am using now and I look forward to it.


Paul

 

[BlueChip Trader]

Grey 1,

At what level of std should you set your alerts? At 2 std, 1.6 or 1.8 away from vwap.

Detail setup criteria would be greatly appreciated.

Zahid

 

[fowkesp]

Zahid,

I was interested in this aspect as well. I understood from a post from a while ago (or rather read into it) that Grey1 was synthesising a statistical distribution from vwap vs price behaviour and then using MCS to model risk and pick optimum entry points. But I believe he using a much simpler method at the moment, and it's not SD.

Grey1: look forward to seeing the TS code that implements your ideas.

Paul

 

[BlueChip Trader]

Paul,

Thanks for your reply. Much appreciated.

 

[Grey1]

Pair trading continuation

To pair trade we must first realise that this concept does not work very well in very strong trending days.. So we pair trade when market oscillates.. it however does not mean it is useless.. it only means you are better off to take directional Trade..

If you pair trade while market is strong then one of your positions does contribute much to create an overall market neutral position

I am going to give you a simple pair trading model and ask you to test drive it for yourself on Monday to get you prepared for VWAP Model ..

This is the exercise..

You need to have 4 charts open

two 10 minute and two 1 minute charts.

On the first 10 and 1 minute chart find a stocks where a simple RSI is OB

On the second 10 minute and 1 minute find a stock where a simple RSI is OS..

Go long OS and short OB at the same time ..


( forget about price ratio and ATR , volatility at his stage)..

Test drive this model till Wednesday .. be as honest as possible with yourself and your trade.. lets say you want to make 40 C then your over all stop loss should be around 20 C..

The objective of this exercise is to see if your mental pressure is reduced or not ( as a result of having a neutralish pos ) .. and if yes to what level.. That is all..

In the VWAP model we define a far better model ...

PS:_- stocks must be OS and Ob in both time frames..

 

[Trader333]

I think the US markets are closed on Monday for Martin Luther King Jr day.


Paul

 

[BBB]

Grey1, V Interesting so far. One question though: As an ex futures trader I would often use spreads. One of the advantages (being a Market Neutral strategy) was that stops were not required due to the neutrality. I admit that both legs can go against you, and I don't know enough yet about pairs trading to make a comparison to spread trading, although there are obvious similarities.

I have no intention of digressing to futures spreads, but to help my understanding, one of the key points of the spread was the relationship between the two legs, i.e. I may spread the front month against a red month in the same product, or I may spread related products such as H Stirling against H Euribor (both being Euro zone STIRS). For your suggested exercise, do you recommend the pairs be in the same sector (AMZN YHOO), or doesn't it matter at this stage?

Are you using stops here incase both legs do go against you?

 

[stevespray]

Grey - Is the 20 point stop based on the nett loss of both positions ?

Steve.

 

[keano]

I would assume so steve. Grey, i take it that at this stage, at least, we are not concerned about picking stocks which have a history/relationship. Just merely picking 2 stocks which are O/B and O/S repectively in both 1min and 10min time frames to trade?

thanks

Keano

 

[Grey1]

Yes steve.. 20 C overall.. the figure 20 is just arbitray .. if you choose 30c then go for 60 C profit to give you a R/R of 2..


Keano ,,, spot on . Any stock from any sector or group.

 

[Grey1]

BBB,

Spread trading as it is known in the industry needs the knowledge of correlation between stocks..

I have given my view why the correlation method is not all the suitable for day trading .. this is why it has been dumped by many day traders including myself,

As long as stop is concern.. nothing is Guarantee in the market and stop is a must.. Tha term market neutral is sort of misleading because the hedging process is not full proof, hence the stop..

By the way , There is not such a thing as a strategy without stop.. STOP is a MUST ..

VWAP model does not need to know the the prior knowledge of stocks and works as the market un folds its hands

 

[BBB]

Thanks - I've been spending the last few hours going through the Pairs Trading thread on the 'other' BB. Should have done so before asking the question.

Futures and their mechanics are very different from stocks so I guess different strategies are used.

 

[LevII]

BBB

Thinking of other BBs, there is some interesting material (from about page 7 onwards!) here:-

http://www.elitetrader.com/vb/showthread.php?threadid=8533&perpage=6&pagenumber=1

Having said that, Grey1's VWAP methodology, if I understand correctly what I have read so far, is light years ahead of anything there.

Regards

LII