I tested pair trading a few days ago, shorted 200 shares of iwm and long 100 shares of SPY, lost 800 dollars in 4 or 5 days. huge opportunity in pair trading arena. 1000 stocks have 500,000 pairs, all moving up and down. any one successful in pair trading?
Well don't judge from one trade. For trade pairing you need to accurately model the two pairs over time which high correlation and find points where the spread widens or narrows significantly to fade or go long the spread. This is the real key and takes the right research software to find and model spreads. Stock relations change so much over time that you have to constantly update, especially heavily traded indexes. Then you have to calculate the correct ratio of the two, it is not always 1:1. or 2:1 or just cash equivalents. Many times I had to play with the ratios until I got a chart and correlation that worked. But then in a few months it started falling apart. It can be a great limited risk way to approach trading but requires a lot of legwork and update.
for pattern trader, the advantage of pair trading is that he can play with millions of pairs, and he can find trades any time of the day. so if there is a robot doing pair trading, the potential profit is higher, since his money is always working never sleeping.
You said you "tested" IWM / SPY pair. Yet, did you do any actual backtesting and how far did you go back in your backtesting ? Generally, what was the backtest results ? wrbtrader
low sharpe ratio < 0.5 from what I recall unless you can find a broker with very cheap cost of borrow or use futures
Should be trading in equal dollar amounts. SPY currently 300.3 so 100 shares = $30,030. IWM currently 158.3 so $30,030 / 158.3 = 190 shares SPY....100 shares IWM...190 shares ***Not a big difference but both are highly correlated so you were essentially short 10 shares of IWM plus the difference in SPY vs. IWM.
Actually the difference is massive. It's not a pairs trade when you're not capitalizing on the spread.
Unfortunately, if he did this trade last week the market was trending higher so being short 10 shares was probably the largest part of his loss & it appears that IWM rose more than SPY also. Just unlucky that the markets were moving higher. Important for pairs trading to get the $$ amounts the same or you've got a directional trade plus the pair difference.
Interesting. I don’t know much about pair trading so my question may be moot. What made your lean towards the short side of IWM versus the long of SPY when the market was trending up last week?
Ok... As El OchoCinco stated...don't make any judgments from just one trade. In addition, I'm going to assume you're manually managing your entry, exit, stop/loss, profit targets. Simply, you're not using an automated trading system for pair trading ? Also, for the past few years, it seems like people have had more success in pairs trading when the instruments in the pair are losing their correlation as in the correlation is declining. wrbtrader