Pairs Trading

[nomish]

Pairs Trading ( formerly terrorist attack)

I wasnt trading when September 11th 2001 happened. And im sorry to bring it up as it may be a sensitive subject to some.

I am a swing trader and its crossed my mind when i go out during a trading day that if some kind of terrorist activity occured, what would i need to do to keep my losses small.

My question is this. Say your hold a $10,000 long stock in the QQQ or DIA position and the news comes out of a terrorst attack on a large scale similar to that mentioned above. (Touch wood).

What the hell do u do? if u have a stop loss its likley to hit it and sell the stock. but how would u guys view a situation like this

 

[tradesmart]

Look on the bright side.....if you're long in the market and they catch Bin Laden, you're laughing.......

If something contrary to your position, long or short, happens; you just have to hope that your stop-loss is tight and gets filled promptly (which is in doubt if the market 'spikes' in either direction... )

Regards

edit - and if your position is 'in the money' use a trailing-stop to protect profits.

 

[nomish]

you have a fair point on that. but like the capture of sadam. the market rallied in the morrning then closed lower.

A terror attack is likely to have more of a long term effect on price right?

 

[Trader333]

Read up on pairs trading that has been talked extensively on this site by Grey1. If you are able to do this then market direction becomes irrelevant.


Paul

 

[Rognvald]

"what would i need to do to keep my losses small."
Obey your rules - it doesn't matter what the cause is when your stop is hit

 

[tradesmart]

A terror attack is likely to have more of a long term effect on price right?

Well, markets tend to 'sell the news' and 'buy the dips' to an extent, and then continue on the way they were going....

I guess that the market will react up/down according to it's happiness/sadness about an event 1-10 on the Richter scale, depending on the perceived economic consequences.

After the down/up turmoil post 9/11, the market rallied - after the up/down turmoil post Saddam, the market rallied.......

I'm just going for a lie-down now.....

Happy New Year

 

[sandpiper]

nomish,

Sensitive or not, it's still a reasonable question. Actually terrorist attacks are the least frequent (thank god) of a wide range of scenarios that can screw you.

A few that I can remember watching unfold:

1) When ruben resigned in 1999 the market tanked. From what I recall the S&P went limit down twice before ultimately recovering everything it had lost.

2) A couple of times in 2000 the NAS went limit down 2 or even 3 times in succession.

3) The whole Bush election fiasco saw some pretty wild swings up and down.

4) More recently, data entry errors on futures orders have wiped hundreds of points off the dow in a matter of minutes.

It's always a good idea to have a crash stop in place when you are trading futures. The idea is that you place it somewhere where, if it gets hit, you are glad it got hit. Even trading the diamonds, cubes, spyders, etc I think it's an idea to consider using stops on the related futures as a hedge.

The other thing to bear in mind is that limits and program trading curbs are there to provide some protection in situations such as those I described above.

The danger is that it's so long since we've seen a limit move on the stock index futures (let alone two or three in succession) that a lot of people trading futures or the cubes/diamonds will have no idea what happens.

I would suggest that you take a good long look at the NYSE, CBOT and CME websites to familiarise yourself with the various safeguards.

I take Paul's point on pairs trading but in the sort of scenario we are talking about it doesn't really apply. Firstly, you are talking about the cubes/diamonds. Secondly, even if you were pair trading individual stocks then in certain scenarios you would get screwed on both positions.

 

[nomish]

your right.

after looking at the chart once something happened, its down then sorts its self out and get back on track quite quickly.

thanks for that.

 

[anley]

Nom

A) I wouldn't worry too much about something like this happening otherwise you've never trade.

B) There's little you could do in strategy to this kind of happening because now it's no surprise to anyone. For example if you had a $100k position back on Sep 11 then you could have still got out of it with just bad losses, stop or no stop. In fact there was plenty of time to still get short. The event was so out of the ordinary that many people didn't know (and rightly so) what to do, and were perhaps more interested in watching the tvpictures than the trading screens.

But now everyone knows that the markets would go limit down straight away, almost without anything trading. So stop or no stop you're pretty much looking at a 5-10% drop immediately.

I'd say you'd be pretty much stuck with the position even if you had a stop in because chances are it wouldn't have been elected and there would be little you could do to argue your case. And even if the stop had of been filled it would have been at a crazy price.

But look on the bright side, the odds are with you because you can only have 3 positions, long, short and flat. If you were short of flat then no problems.

 

[nomish]

thanks for that anley

 

[Trader333]

Sandpiper,

Secondly, even if you were pair trading individual stocks then in certain scenarios you would get screwed on both positions.

I dont see your argument for this, if I am long one stock and short another then news will cause a ramp up or ramp down of both but my positions effectively cancel each other out in this case so why would I get hammered ?


Paul

 

[sandpiper]

Paul,

Oh yeah. You are right, of course. Aplogies about that. For some reason, when you mentioned Grey1's pairs I had something in my head about negatively correlated stocks where you would be short or long both of 'em (how stupid was that thought eh

Apologies again.

 

[anley]

Watch Pairs trading because on paper it gives the dangerous illusion thatnothing can go wrong with your positions if the overall market makes a big move.

What happens if you buy say Vodafone and sell BT short and then something very bad happens in the market. Vodafone could lose 15% whereas BT only 5%, a major loss with the overall trade.

Pairs trading at the end of the day is just as hard to make money on over the longer term as simple directional plays. Sure you are in a lot of cases taking the overall direction out of the equation but then in reality all one is doing is substituting one market that fluctuates (stockmarket) for another market that fluctuates (the relationship between 2 stock prices). And then once you factor in the cost of doing business (not just comms but 2 bid/offer spreads) and profitable pairs trading can hinge on transaction costs especially if you short term trade.

Brokers by the way love to talk up pairs trading for obvious reasons.

 

[Grey1]

Anley,

Quote "What happens if you buy say Vodafone and sell BT short and then something very bad happens in the market. Vodafone could lose 15% whereas BT only 5%, a major loss with the overall trade. "

VOD and BT can 't be pair traded .. There are rules in pair trading you have to learn . Try Tech stocks against either Gold or Bio stocks.


Quote " Pairs trading at the end of the day is just as hard to make money on over the longer term as simple directional plays "

Pair trading needs extensive knowledge of stocks and their volitality.. Pair trading reduces the risk... This is the best part of it.. ..

it is much harder to try to predict the direction of the market than pair trade..


Grey 1 pair trades 2 -3 postions every day.

 

[2468steve]

Grey1
excuse my ignorance,but why cannot pair trade Vod/Bt......surely you can just buy one,sell the other.

cheers

 

[Grey1]

sand,

Quote "Oh yeah. You are right, of course. Aplogies about that. For some reason, when you mentioned Grey1's pairs I had something in my head about negatively correlated stocks where you would be short or long both of 'em (how stupid was that thought eh "


What did youhave in ur head ? Not sure what your logic is..

 

[Grey1]

Steve.,,

VOD and BT are parrallel trades and not a pair trade..

In parallel trades stocks shadow each other like BT and VOD and one can 't eliminate the maket direction from parallel trades.. For example you wont go short YHOO and Long AMZN .. it would simply be silly..

Of course you could go any stock long or short but is the choice of stocks which makes this subject so interesting..

There are many ways of pair trading

1) correlation anlaysis ( choice of stocks )
2) Vwap analysis ( weakness/ strength )
3) beta analysis ( Swing intensity )
4) EVT analysis )(risk analysis)

regards

 

[2468steve]

Grey1
thanks for explanation.... would this apply to banks also...Lloyds would have been a good sell,with long in say barclays

cheers

 

[anley]

Whichever way you slice and dice it, a pairs trade is simply a spread trade between 2 related instruments. BT/VOD are linked, YHOO/AMZN are linked and so is Tech/Gold.

But as I said before if you spread trade any market you are basically substituting one market that fluctuates for another. There is no escaping that you can easily lose using either strategy but find it hard to make CONSISTENT money OVER time using either strategy.

As for a reduction of volatility, then sure no doubt this is a somewhat by-product of pairs trading. However it's very possible that at some stage in the future all of ones carefully planned strategy and thesis on where certain stocks or indexes should trade relative to each other blows up and the 'reduced volatility' aspect of the game was no more than an illusion.

Spread trading to me is similar to options, they look so simple when first introduced to them and pretty easy to understand. But like an iceberg there's a hell of a lot more information and problems lurking below the surface.

 

[Grey1]

Anley ,

May I Invite you to read a bit more about this technique.. Your post did not carry an objective way of criticizing the technique..