Pairs Trading Strategy Model

Discussion in 'Strategy Building' started by Neutral_Al, Sep 5, 2002.

  1. nitro

    nitro

    trader,

    as usual, you are right on the money. I have stopped pair trading altogether until I see another way...

    It was a gold mine for me for a while, and then it just went COLD.

    nitro
     
    #141     Dec 2, 2002
  2. Bob111

    Bob111

    Probably for reasons, that I mentioned above, but nobody pay attention to it till you get it…:D :D :D
     
    #142     Dec 2, 2002
  3. man

    man

    thetraderprofit,
    why don't you choose your words more carefully? It is possible to have an opinion without being aggressive.

    Since I am a person starting to trade a non linear pairstrading strategy tomorrow, I feel a little offended.

    I understand quite well that there is a special (cool?) way to talk about things, but this is a free forum and the right of free speech works best, if people try to choose their words carefully. Abusing it means diminshing it.

    Sorry, if I am now offending.


    peace
     
    #143     Dec 3, 2002
  4. man

    man

    Perugino,
    I agree with you. What you are actually claiming is, to use the very best computing facility on earth: the human brain. Now this brain is the perfect tool for learning. Imagine where humans live, from coldest ice to hottest desert, and it is the adaptive capability of the brain which makes this possible. Two children of about four years were found in india who were raised by wolves. It was impossible to make them behave like human beeings - they learned for years to behave like wolves; moreover they became wolves.
    If you train your inner system to the markets in the right way, you will inevitably beat the best machines in the best funds out there - no doubt about that (another thing is how to organise the learning process, since frustration is a hard hindrance for the learning ability).

    There is one thing where the human brain is really bad and beaten each and every time by any standard PC: processing mass of uniform data. This is not a good field for our structure to work in.

    Now being aware of that, there is several things one can do about it. First is to ignore computers at all: will work with proper training on few markets - no doubt. Second use small computable edges on a mass of instruments and profit from combining what a human brain could never combine. It works because the inefficiencies are so small and vulnerable on the single market, that they are not tradeable for the first category of traders.

    Now, is there anything special about this? no. Use computers to the amount where they really support your brain. Your example with the theorists is right. The same accounts for many traders who neither use their brain extensively enough nore rely on computer power.


    peace
     
    #144     Dec 3, 2002
  5. Perugino

    Perugino

    Man,
    The proof of the pudding is in the eating- If Ihad made a million dollars from tecnical analysis I would be praising it and having a discussion on its forum- I havent so I am here instead - what attracts me ? The notion that if an indices(r) is oscilating around a mean I stand a good chance of predicting its path.
    My model isnt complex!
    Its not really scientific.
    - but that isnt to say computers cant assist- lets face it if it wasnt for the computer we wouldnt be here !!
    You know- thereis alot against us succeeding at this - I want to digress on your point on the human mind- when we win our bodies change we become lightheaded and optimistic - what do we do - convinced of our success we invest more in our "proven" technique only to see failure. Its about balance - account for the fundamentals - the blow out (5-10% ??)
    We must all feel we can succeed or we wouldnt be here !!!
    LETS GET UPBEAT -


    As Abe said
    "Good things come to those who wait - but only what is left by those that have taken the initiative"
     
    #145     Dec 3, 2002
  6. man

    man

    right.

    peace
     
    #146     Dec 3, 2002
  7. Man,

    I wasn't trying to be aggressive, only humorous.

    But....

    You seem to be saying, "I'm going to start doing this tomorrow
    anyway, so please don't bum me out ."

    Well, sorry, but here are the facts:

    I know quite a few people who make a living at pair (or pairs)
    trading. It must work to some degree, and I use it around the opening, or at the opening, particularly when there are upgrades/downgrades/news.

    When I say, "a living", I mean a very good living --low to mid six figures. One guy uses it on bond futures and is up $1.5-$2 million this year between bonds and stocks. Of course, the position sizes necessary to generate these profits are such that great damage can be done to your net worth......just as with any arb strategy.
    For example, the guy who is up $1.5-$2 mill, had, at one point, $1.2 BILLION in long/ short bond futures positions. Yes, that's a "B", not an "M." I'm not sure what the haircut is on that position, but his firm was obviously at risk--not just him.

    To a man, these pair traders do NO fundamental analysis, and almost no technical analysis. Their selections are based almost entirely on past price relationships.

    Now, having encouraged you with the above, I know of many,many more ex-traders who lost all of their capital with this strategy. I say I know "of" them, because they remind me of the poorly-trained new recruits sent to the front during WWII, never to be seen again. The experienced soldiers didn't want to know their names. Unfortunately, some of the new recruits were friends of mine.

    Here's an example of the risk of any arb strategy gone awry. In August, I lost $10,000 in an arb involving 2,000 shares of a $2 stock. The short side rallied and the long side dropped 80%. So, the point is that all arb strategies are risky. Usually, a great deal more risky than you first assumed.

    I do pair trade, primarily with low volatility stocks like REIT's.
    I do some fundamental research, but not much. But even pairs of VERY similar stocks like FNM/FRE have blown out many a trader.

    Man, I don't pretend to have some of the answers, just all of them!

    (My private pair(s) trading course is available for the small fee of $100,000)
     
    #147     Dec 3, 2002

  8. Hi Nitro,

    What was the reason you stopped pairs trading? Was it the pairs that blew out because of earnings? Or was it because you just got bored with small profits and those positions that went nowhere for weeks?
    I feel the same way sometimes. But look at the reality. The most successful hedge funds are the market-neutral ones with profits on the order of 20%+ per year. Look at Pairstrading.com... Even with most positions going against them at first, they still manage to show profit of 1 - 3% per mo (9mo out of 11 that I saw). Look at FO/ ITT... I traded it successfully 6 times in the past 2 months with total profit of 30%+. I went long ITT/short FO today again.
    Making money trading pairs lacks glamour and thrill. It is a slow process of adding 1, 2, 3 percentage points to your capital at a time. But that is how MONEY is made.

    Good luck,
    Al
     
    #148     Dec 3, 2002
  9. man

    man

    thetraderprofit,
    I see your point. In the end it is all about results. Thus we do not have to argue the ifs and whens. We do our first thirty pairs today and will see how things turn out.

    I find your approach quite interesting, since we could prove that although the morning session is the most volatile, it is the time were pairs are most integrated. I do not want to get into detail, since I assume this would bore you, but I think trading at the beginning of the day offers opportunity.

    You mentioned FNM-FRE. It is very funny that with standard technology this pair can hardly be traded, although it has a 0.65 correlation even on five minute data. this is astonishing since this correlation must come from somewhere. meaning someone is trading these stocks parallel otherwise this correlation could not sustain.

    My understanding of trading is to have a wide portfolio with a small edge in each trade. This is not at all satisfying for a daytrader who looks at a dozen stocks, where he has a rather big edge.

    Sorry that I did not get your humour immediately ...

    peace
     
    #149     Dec 4, 2002
  10. I disagree that it lacks glamor and thrill. I guess it just depends which stocks you're pair trading. If you're feeling really sexy, try UNH/WLP, or some of the brokers; thus, my references to gambling, and smoking crack.
     
    #150     Dec 4, 2002