Pair Trades

RogerM

Established member
752 6
The subject of pair trades was raised on the "typical days trading the US" thread. Here are some links as an initial starting point. There will of course be many others.

http://www.tradetrek.com/education/pairtrade/market_neural_strategy04.asp

http://www.newbridgesecurities.com/reports/marketneutral_1-25-02.pdf

http://www.pairtrader.com/products.html

http://www.pairstrading.com/content.asp

http://www.tricom.com.au/equities/articles/pairs.asp


The following explanation of the concept has been lifted verbatim from the Tradetek site.

What is a market neutral trading strategy?

Under most circumstances one cannot be sure about the direction of the market (e.g., Dow Jones, NASDAQ, S&P 500 index, etc.), especially in the short term. A "market neutral trade" is a trade that does not get affected by the movement of the market as a whole: it is a trade that does not lose (or make) money simply because the overall market moves up or down. Through research on individual companies, you can gain views about the strengths and weaknesses of individual stocks. With this knowledge, you can implement "market neutral trading strategies" by buying stronger stocks and selling short weaker stocks. If you buy a certain number of shares of a stock and, at the same time, sell an appropriately chosen number of shares of another related stock, you can create a "market neutral" position that is hedged (i.e., immune) against uncertain market movements. If the market as a whole goes down a lot, you will most likely lose money from the stock you bought but make money from the stock you sold; if the market as a whole goes up a lot, you will most likely make money from the stock you bought but lose money from the stock you sold. The idea is that if you choose the stocks and the numbers of shares (that you buy and sell) appropriately, the gains and the losses due to the movements of the market overall offset each other.

What is a Pairtrade?

A Pairtrade is a special case of a market neutral trade. In a Pairtrade, you buy (go long) a stock, and, at the same time, you sell (go short) another stock, believing that the stock you go long is relatively stronger than the stock you go short. If the market goes up, you make money from the long stock and lose money from the short stock. If the market goes down, the opposite occurs: you make money from the short stock and lose money from the long stock. In either case, you are hedged against sharp market movements (up or down). A Pairtrade tries to capture the relative value between two stocks: in a down market, you expect the stock that you buy to drop less than the stock that you sell; in an up market, you expect the stock that you buy to move up more than the stock you sell. In either case, if the analysis of the individual stocks is correct, the trade results in a net profit without exposing you to the risk of overall market movement.
 

iq200

Well-known member
347 15
Hi Roger, There is quite a lot of information on elitetrader on pair trader. In particular look at the Jornal of a guy called Don Bright which I believe, is about Pair Trading.

Regards,

Imrana
 

Grey1

Senior member
2,186 178
Thanks Roger for all the above info..

There are few basic ideas that I have pointed out in my previous posts on this BB for intra day trading ... To summarize them they are

1) pair trading ( look into sites above )
2) VWAP
3) Risk ( Entry is the key )
4) Relative strength of stocks with a leading index


Vwap is volume based mean price.. VWAP is important in intra day trading because it ca n’t be manipulated by MM’s .. it takes a huge volume to move VWAP by even 1C.. So if a stock falls below its VWAP then we can assume it is a good short candidate.. Extreme deviation of price from VWAP ( the deviation of around 2Standard deviation from VWAP gives 95% chance of a revesal to the VWAP.. ) should be noted and those stocks should be marked and watched as good intra day candidates..


Relative strength

By relative strength I don’t mean RSI.. RSI measure the strength of a stock with it self .. We are interested in the behavior of stocks with a leading index.. Relative strength gives you a lot of info if watched carefully.. You basically want to know what happenes to stock if Index falls ? Does the stock follow and if yes by what rate ( faster or slower) .. .. you get huge edge just by watching this behavior..
 

ZigZag

Active member
123 0
GREY 1...........VWAP sounds interesting. Does your software package provide the calculations for intraday price/volume movements or do you use E.O.D. data then manually calculate the price/volume average.... Norman
 

Grey1

Senior member
2,186 178
zig zag,

Some platforms offer VWAP as standard such as Realtick from Townsend try www.ird.com.. IB does not offer VWAP quote which means one has to have an external routine to calculate that in Real time.. I use VWAP in realtime ..
 

Grey1

Senior member
2,186 178
VWAP is average price of stocks.. You can however use a leading stock such as MSFT or any other stock that you feel shadows the movement of your trading instrument and super impose the chart of the stock on top of that particular instrument and use the VWAP of the stock as a reference or bench mark for your trading..
 

al-motor

Active member
249 0
Interesting article Grey- sounds abit like delta neutral options trading- needs specific skills......... and software etc
 

RogerM

Established member
752 6
Oldun - from memory, I think there are something like 78 pages to this thread. You need to scan forward to at least page 7 or 8 where an interesting discussion on pair trading Freddie Mae and Freddie Mac gets going.
 

warm_machine

Member
70 0
Had a quick read...not a great deal to be learned from what's there...that is, there's a great deal of info there, but not what I would call useful...also US orientated and since UK/Euro pair are better correlated I don't think those interested in the field need look outside the UK and European markets.
 

Oldun

Active member
139 1
Roger,

Thanks.

Your tolerance threshold is several pages better than mine. I'll look again.
 
 
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