Pairs Trading Strategy Model

Hi H2O,

I opened a new position yesterday at 1400: Long PPH / Short XLK.
Entry ratio 3.9552. Exit 4.3. Stop loss 3.89.
Will keep you posted on progress.

Regards,
Al

 

Here is the chart

 

This is an excerpt from our recent pairtrader monthly news letter.

//
Changing of the guard.

After talking to experienced traders over the last couple of months, I hear a lot of traders saying ‘remember the good old days’ or ‘if the market was only the way it used to be’. Personally, I am already tired of hearing this. I fully expect that two years from now the current market will be called the good old days. Learn to change, learn to adapt, this is the only way you will be able to succeed in the long run.

Of all the things that traders lament it is the disappearance of easy money. Trades with low risk, high rewards, and instant gratification no longer seem to exist. Simply put, stocks are no longer giving the prints they used to. These prints allowed mediocre traders to achieve good profits in previous years. Pair traders, in particular, had a great advantage in this type of a market. They where in a position to capture a lot more of these prints since they where in so many trades to begin with.
With the easy money being taken out of the market what is going to be the thing that replaces it? I think the answer lies in one of two camps: either trade with patience or trade spreads with little risk and little rewards.

When I said earlier that I expect the current market to be the good old days two years from now, here is why: currently, my business plan with spreads in general is as simple as being patient in executing my first leg of capital, be patient in taking profits, competent management of positions, and making lots of money. Two years from now I will be begging for the days when you made a simple business plan, stuck to your guns and made money.
//

You can still make money in this market, and you can still make money trading pairs. The problem is you can't make easy money right now. You can make a million a year still, but you need to take more risk to do it. The people who will succeed in this market are the people who are able to understand risk reward relationships, trade probabilities, and stick to systems.

Cheers,

Darren

 

Darren,

Several questions for you, if you don't mind.

1) How long have you personally been trading pairs?

2) What time frame do you use for your trades? (i.e. typical trade held for hours, days or weeks)

3) What annualized percentage return do you expect from pair trading (max 2x leverage in your positions)?

Thanks,
-Eric

 

Darren,

I would also like to ask - intrading pairs, do you add on to a losing pair position or do you adhere to a stop loss? If you adhere to a stop loss system, how far should a pair go against you before you exit?
Also, is your chatroom still in operation?
Thanks.

 

It was asked how long I have been trading, this is month 16. Not too long, but the joy is that I am trading profitably in this market where others are struggling.

As far as the time frame of my trading, I trade everywhere from 20 second trades, to holding for two months. Generally I am not trading longer than this. I am looking to increase my time frame with some of my trades as I have a bigger capital base to work with now. The market seems to be favoring patient people.

As far as an annualized percentage return with two times leverage, I would expect returns between 25 and 30 percent.

With intraday stop losses, I do use them but in a different way then most people. I will never sell the bottom unless I really see something in the tape to make me want to get out of the position. I will wait until I get retracement to a two minute moving average. Lighten up on some of my position and then revaluate. If it continues in my favor I will be patient to take off the remaining position. If it goes against me I now I have known resistance point. Remember: the reason why you get into a trade justifies where you get out of a trade. Whether for profits or for losses.

Cheers,

Darren

 

A lot of traders (now ex-traders) I had traded with blew out their accounts by pair trading the "traditional" way - meaning keep adding on to a losing position until the pair either comes in for you or ends up hurting you in a very painful way. I was toying with the idea of observing a predetermined stop loss if a pair goes against me instead of adding more units to the position indefinitely. I plan to only hold 1 unit for each pair, close out most positions at the end of the day, and close any position once my stop loss is hit.
Has anyone tried this method of pair trading? I like the advantage of being hedged but cannot stomach the idea of adding to losers.
Any ideas, anyone?
Thanks for any input.

 

Reg, I know a lot of traders who have blown out their accounts over the last year trading pairs in the 'traditional way' as well. Most of these traders did a very poor job of understanding risk reward relationships, and 'business as usual' environments.

Unless the probabilities are highly skewed I never risk $1 to gain $0.2. I am amazed at how often spreads develop common consolidation areas, or have tendencies to trade like individual stocks with no trend. I look at my historical chart and figure out where the next area of support or resistance is and calculate my risk to there. Some times this is dollars away from my current level, in which case I should not be adding to my position every $0.3. Only add when you would take the trade from scratch. You need to be able to justify why you are in the trade and why, based on probabilities you are adding to a position.

Most trader add to a loosing position because they do not like the red p/l they see on the screen. Hide your profits and losses while you trade and only trade probabilities. For me the only time my profits and losses enter into my trading decision is when I am down half of my account, at which point I cut everything to make sure I can trade tomorrow.

The 'business as usual' environment comes from spreads trading within their historical ranges. If I see that a spread has traded in a $30 range over the last three years, it should not seem that odd for the spread to trend $10 in a month and revisit one of its historical highs or lows. My business plan needs to alot for this, and I design my stop losses accordingly.

The rule for adding with me is actually simple; first: don't take the trade unless it stands on its own. Second, stop out of a spread when you are not willing to take the loss all of the way down to the next support or resistance level. For the most part I have been having great success in this market by being patient, being willing to accept some pain and extending my exit points to justify the risk.

Hope this helps,

Darren

 

Thanks Darren. Great explanation.
Is the pairtrader chatroom still in operation?

 

Yes, the chat room is still working. There is a limited number of seats available. You can access it by going to www.pairtrader.com and clicking the portal link on the right hand side of the page. On the next page click the join chat room button on the left side of the page. You have to download some software, but this happens automatically. Feel free to come and join us.

Darren