since so many prop traders trade pairs(in this case a pair in stocks/ETF/Indexes)) recognizing that a pairs trade is a spread(one position long, one position short)and is already partly hedged, how have some of you been practicing risk management? adjust position sizing? use options(assuming one of the stock/ETF/Indexs are Optionable), some other strategy?
Just keep the $$s long and short. Now, don't misunderstand what I'm saying here. Many of us tend to keep about 10% long to make up for the normal upward bias of the market. You can adjust this with your own interpretation of near term market correction of course. Don
Don can you clarify? I guessing you mean avoid being strictly dollar neutral and skew one side by a percentage. or do you mean something different?
Yeah, pretty much..decide a good ratio enter the trade. I use a 130 to 100 on one of my pairs to start with. I can normally put on a couple of layers, and close them same day or in a day or two max. But sometimes, it just makes sense to adjust the share ration (monthly seasonality, things like that). We have hundreds of pairs, with various ration, showing dozens of column of analytics to work with, adjust as needed. Keeping it simple, once again, LOL. Don
gotcha. and is "layer" your term for adding more shares to both sides of the spread....when warranted?
Yep. Trading range from say, $40-$60 for last 6 months. Two stocks, range of differential say $5.00 during that time. When spread goes to $4 you sell a layer, maybe 2 layers...since you don't want to take the first layer off....(sidebar: reason for this is that if this goes against you, you add another layer. But if you 50 cents or whatever, you close out...well, what happens when it goes $3 more in your direction? Right, no profit). Then if goes up to near $5 you can sell another layer, have either two or three max (for now), take off on with at least 10% of the 6 months range $.50 for this example. Keep the other one with a "mental" trailing stop or trigger. Don
All about proper trading size. With limits, Mr. Maverick. As you know, when we do martingaling, its at baccarrat...and don't suggest it, LOL. Stupid table limits....have to recruit family members to increase bet size.... Don
Try swing trading them for trend, and quit playing rich / cheap fade-monkey. Works wonders. You might want to hang on to them a bit longer due to the stat arb turbulence. I agree about keeping your longs and shorts dollar-equalized. And choose sensible combinations within correlated market sectors and similar market caps if you can. I've also had clients cut back on trading size and position selection during earnings season. Love that Bloomberg beta scatter-plot functionality.