Pairs Trading

[Trader333]

ERTS Trade:

 

[Grey1]

Well done Paul,

This was a cool trade..
For the attention of our younger Traders:--

If you use VWAP analysis and market goes in either direction one postion will fall faster than the other because you are taking a position at the outer VWAP bands.. Ideally both positions should be profitable and this is often the case ( mean reversion ), however if it does not , then one position often loses much less than the other resulting in a profit.

regards

 

[Mr. Charts]

A pair trade today - same concepts as I've mentioned before.
MERQ short 48.10 15.24
covered 47.08 17.39

for profit +102

IMCL bought 44.92 15.41
sold 44.97 17.40

for profit +5

So, a decent profit of +107, but frankly it was not very wise of me to do a pair trade today. It was really a day for directional trades!
Richard

 

[elliottmillion]

nobody should have been long in the days before september 11th, as it was clearly going down before then!!! in any event, your stop loss maybe restricted somehwat, especially if spread betting as "force majeur" comes into affect, and they can't get out themselves.

 

[jklondon]

trade here?

totally fresh to pair-trading. based on lastminute / ebookers chart - is their an opening for a trade ? i.e. convergence between the two ? What should I really be looking for to validate entry ..

any-advice appreciated

 

[jklondon]

Here are the charts of the YHOO and ERTS pair trade:

The first trade was the Short of YHOO at $47.52 and then the Long on ERTS at $48.41. YHOO dropped but ERTS was mostly static. YHOO continued dropping below its target and continued and at this point because ERTS had still not moved I was looking for a retracement by YHOO to exit both trades. This happened and I closed both trades for a profit of 39 points. The profit had been as high as 51 points but as I didnt know this was the optimum time to close the trade I let 12 points go back before closing it.

I hope it is of interest.


Paul

Paul - why YHOO and ERTS i.e. what indicates they are suitable 'pairs' ?

 

[Trader333]

JKL,

Both stocks had crossed their outer vwap bands, one as overpriced and one as underpriced. This, with other considerations, made them a good opportunity for a pair trade at that time on that day only.


Paul

 

[theknifemac]

JKL,

Both stocks had crossed their outer vwap bands, one as overpriced and one as underpriced. This, with other considerations, made them a good opportunity for a pair trade at that time on that day only.


Paul

Paul

When you say vwap bands do you mean something like Bollinger bands applied to the stocks vwap ? So you are expecting both vwaps to revert to the mean ? What would happen if you had two stocks at the lower band and one at the top say - how would you pick the lower stock to match the upper one ? Do you ever look at historic correlations between the stocks / do you always want them to be in the same sector or anything like that ?

I'm full of questions today aren't I !

Cheers

Stew

 

[Trader333]

Stew,

When you say vwap bands do you mean something like Bollinger bands applied to the stocks vwap ?

Sort of but also not really, what you get is a vwap price and then you add and subtract a figure known as Maximum Permissible Deviation (MPD) and this gives the upper and lower band limits.

So you are expecting both vwaps to revert to the mean ?

No not necessarily, I would expect one of them to return to its vwap and it is not necessary for both to do so. That said you often get both moving back to their vwap constant and in the event that both move in one direction then you have a market neutral position that keeps your P&L at breakeven. The ability to do this type of trading is highly dependant upon overall market conditions for the day being considered and some days pair trading is just not suitable.

What would happen if you had two stocks at the lower band and one at the top say - how would you pick the lower stock to match the upper one ?

You are not going to like my answer to this one because it is largely down to experience

Do you ever look at historic correlations between the stocks / do you always want them to be in the same sector or anything like that ?

No and No because it is only applicable for day-trading and in particular only on the day that they are traded as a pair. Other days the chosen pairs would be totally unsuitable and this is why this style of trading is quite good in my view although in more recent times I have traded more directional trades than pairs.


I hope this helps Stew


Paul

 

[theknifemac]

Thanks Paul, can't be bothered to do all the quote stuff as my stomach is rumbling :cheesy:

How do you determine the MPD - is it stock specific ?

I get you that both may not return to the mean but on balance you hope that one will while the other at least does not deviate further ?

By historic correlations I meant historic intra day correlations rather than dailys, but reviewing your answer it looks as if it could still apply. I've seen a thread on ET where people were doing a lot of correlation analysis to pick their pairs.

I also appreciate that some days would not be suitable for pair trades at all - that itself is useful knowledge though if we can decide it early enough in the day !

Thanks for the answers, have always been interested in pairs trading and mean to do further analysis sometime as the approximately market neutral feature is one I find attractive.

Must get some food now

Cheers

Stew

 

[cwilsson]

Pair trading

Hello,

I am new to pair trading and will buy some books about the subject. Can you suggest one or two books about pair trading?


//CJW

 

[Mayfly]

Hi CJW,

You could try this one for starters:

http://www.wiley.com/WileyCDA/WileyTitle/productCd-0471584282.html

It's not available over here at the moment, but you can get a copy from here:

http://dogbert.abebooks.com/servlet/SearchResults?ph=2&PID=1302937&isbn=0471584282&AID=7153913&sts=t

Apparently, it's actually quite readable.

HTH

Cheers

Mayfly

 

[bampairtrading]

Pair Trading Books

Hello,

I am new to pair trading and will buy some books about the subject. Can you suggest one or two books about pair trading?


//CJW

Here's some books that you might be interested in:

The Handbook of Pairs Trading
Douglas S. Ehrman

The Elements of Pair Trading: A Comprehensive Guide for Traders to the Market Neutral Investment Strategy
Douglas S. Ehrman

Pairs Trading
Evan G Gatev

Trading Pairs + CD
Mark Whistler

Also if you are interested in learning more about pair trading please visit our blog which reviews our daily pair picks (some of our pair trades which are listed on the blog each day) some free pair trading tools (such as Henry Carsten's Pair Trading Tool) and also our BAM Pair Trading Strategy:

 

[Chode]

I've been profiting from pairs trading very nicely recently, but I have to warn you guys: Big events in companies create HUGE risk, this doesn't count only for pairs trading but for all trading, short or long. I realized yesterday how crucial are stop losses even in pairs when one my short leg (CSHP) got taken over and the price was changed from 50 to 90 which shaved about 30% from my account. its pretty rare BUT can happen, and not only once in a lifetime . Its going to take a while to make this back specially when I'm forced to trade smaller size. So beware and use stops! Or are you guys using any methods for avoiding these kind of events? any thoughts/ideas are welcome

 

[RVLS]

(Hope this thread is not completely dead)

I trade pairs too. A stop gets blown away by this kind of takeover announcement. Only one method to reduce the hit - small position size in a portfolio of many holdings. No other way to handle company risk that I know of.