I'm new to this thread, and would be happy to contribute with ideas for pairs. I'm also interested in money management techniques given recorded performance data, as I am a disciplinedtrader. I trade UK, European and US stocks. What are the pairs that others are using? How do you guys set an exit point for the trade, and in particular for losses?
I've been pair trading for awhile and wondered whether anyone uses specific techniques for pair trades that go against you for one reason or another (e.g. surprise earnings announcement, contract win, broker upgrade/downgrade,...etc). For example, say I short Stock A, and go long Stock B. (Take it for now that both stocks are in the same sector and have a correlation coefficient, r, of at least 0.8). A day later and Stock A has a broker upgrade. My experience shows that in such an example, despite the high correlation coefficient, A would be more liable to rally than B would. Therefore, if the mean dispersion continues to increase one could:- a) re-enter twice as hard b) take the loss on Stock A and ride Stock B hoping that momentum from upgrade of Stock A will spur Stock B on even more c) do nothing and let the original pair trade continue I just wondered what are people's thoughts on this and how do you control the unexpected when pairtrading? This kind of leads me on to ask what type of drawdown people experience from pair trading. (I'm really talking % from overall market exposure from both pairs). Thanks, Mikee
Generally money management is don't put more than 30% of your account in any one position, in that case even if a stock halves overnight you have only lost 15% of your a/c. Most of us here don't use stop losses, only exit when the pair comes back to the mean.
You can control the unexpected through prudent risk management, just I said in the above post, don't put more than 30% of your a/c in any one trade, therefore a large price move won't affect your entire portfolio, to mitigate the risk of these events you can choose not to take trades several weeks prior to earnings release, you can even choose lower risk stocks, those with fewer news items released, fewer analysts covering them, etc.... Just to give you an idea, In this journal Ive returned 104% since last August and my biggest drawdown was 8.9%
If the announcement pertains to a genuine development in fundamental differences between the stocks than the traditional statistical relationships are likely to breakdown. In other words you've lost the anchor by which to revert back closer to a mean. My 'solution' to the general problem is.. 1 Adopt a timing based approach to trades. If we are aiming for a 'snapback' from a 2 standard deviation event, then (given the historical evidence I've seen) it tends to happen within a few days. Otherwise you get this nasty snaking pattern whereby it hugs the bollinger bands upwards/downwards whilst you do your pieces. So in other words, open a trade, hold it for, say, 5 days and close it after that if it hasn't triggered your exit points already. Other ideas include 2 You could also create an algorithm or use 'rate of change' indicators to try and pick a spot when the ratio eventually roll over. 3 Of course, if you think that the event (ex a broker rec) tends to negatively impact the trade in the short term, you could immediately reverse the trade when it. I prefer to close the trade and just walk away from it.
Have you ever looked at using Kelly Optimal fractions in order to control money management? I'm new to this and am trying to build up some data with which to estimate these fractions. I guess that trading when it comes back to the mean, means that the average Win and Average Loss will be assymetrical. Have you thought of setting targets with a fixed stop loss/take gain (say 2% ex comms) and that way, if you have a winning record it wont be hard to work out how to manage the risk of ruin, but still optimise return?
jonny Have enjoyed this thread since inception. i know earlier you said that all your trades are put on at the close because they reflect a more true price range (i dont recall the exact quote). I find your buy and sell prices don't ever vary from YAHOO closing prices. Are the prices you post real money.....that reflect your trades. MOC trades of brokers often differ with YAHOO but i don't see this difference in your trades(i have not checked all of them) that i have reviewed Your trades have all been accurately logged but wondering why there ae not occasional differences from YAHOO's closing prices thanks cheers john
What technical indicators do you use? Usually i try to spot pairs, where RSI is near overbought/oversold levels ...