I have no clue about the future so I do over/under valued pairs trading on illiquid stocks (realtively moderate potential loss since one side hedges the other). I suppose it's a reversion to the mean concept. The idea is to try to capture some of the spread b/t the two. Where it gets interesting is with a group that correlates so that you can swap in substitutes for winners. IOW, if both legs rise, take the profit on the long leg and replace with a new long leg. Conversely, if the pair moves down, cover the short leg and replace it with another short. As a result, you're always booking gains which the market can't take away - as opposed to cutting a losing leg and holding the winning leg, which a gap will clobber. Gains doesn't mean profits. You need the spread to narrow or one side to reverse. I shift my bias intraday (more long than short or vice versa) but I get close to balancing out for overnight since one never knows what the morning will bring. There are so many ways to make money in the market. This one worked beyond belief when the market was melting down from late '07 to mid '09 - it has moderated considerably since.
Thanks for this. I've heard of people trading like this. In fact, the only other trader that I know in the flesh, said he believed this was the only way to make consistent money. That said, he wouldn't tell me anything about the details unsurprisingly. Of course as mentioned before it seems a lot of successful traders probably presume their way is THE way. Anyway, I'm glad it works for you and it is on my things to try to learn more about. I suppose the first inital trick is trying to determine which markets are closely correlated enough to run this. Do you do this on equities or futures?
Thank you for sharing. That's a pretty sequence there. Sometimes I wonder if it's really that simple and people like you when they present it make it seem more convincing that KISS is the best way. Maybe William of Ockham was right? I mean I understand why cutting losers short and winners works. First of all it's against human nature, secondly it allows one to capture excessive gains in te form of the occasional fat tail.
No, no, you are flat wrong and a victim of misinformation mechanisms activated by those losers to confuse people about the nature of their acts. The reason they failed was BAD MONEY MANAGEMENT and excessive risk. They blamed it on randomness for obvious reasons. Randomness cannot destroy anyone overnight or in such a short period of time like some of those losers you mentioned unless one is leveraged to the roof. Their accounts were not depleted slowly because of consecutive losers. It just happened that they lost it all instantenuously more or less. That is an act of foolishness, not because of getting fooled by randomness. There is nothing random about this world will live in. Everything has an antecedant, proximate cause. Unless you believe in magic. I don't. My mon never read to me magic books to fall to sleep.
Yep, the correlation is essential. Without it, you're depending on randomness which can be hit or miss. As mentioned previously, it's on stocks. When there's fear in the market, stocks fall at different rates due to panicked sellers. For this reason, it works far, far better in a down market. I could use another bubble
I have never pair-traded, but it always struck me as riding two horses at once. And never having ridden a horse, I can only imagine that riding one at a time would be easier. (Fewer variables, and all that.) Perfect scenarios aside, I would think that any "reduced" risk of pairs trading would be met with at least a commensurately reduced return relative to that risk. Just guessing, of course. P.S. Like it or not, you're still effectively taking a position on direction, relative as it may be. And if you're staggering the legging in and out, then you are relying even more on timing. Again, since I never pair-traded I'm just guessing here.
Like the fact you are educating yourself and you are taking initiative to post here albeit a long post. I have said this many times over the years - you can turn the simplest technique into a profitable trading system if you take the time to fully understand how to use it, when to use it, what to use it on. Then you have to learn proper trade and money management techniques and get experience with your system. Then you could have your edge. There are no short cuts - takes most day traders 1-3 years of hard full time work to become consistently profitable.
Like and unlike so many things in life though, this one seems to be worth the effort. I'll try to focus on the simple things more to see if I can take them to profitability. Seems likely those simpler things have a better chance at being robust anyway. Thanks,
Actually, rising two horses is far easier than riding one horse. With one horse, it's purely directional. You're right or you're wrong. With two, if you have your correlation down, both moving up or both moving down is a non event. It's the disaprate rates that matter. In a sense, it's like doing vertical spreads with options except you don't really have to get the direction perfect. And yes, you are correct. There is a reduced return relative to the risk. Much of the success depends on either having a high win rate or a high profit to loss rate per trade or some blend of both. If you achieve that, then voume provides the accrual (total traded over time not shares per trade).