Pairs Trading Strategy Model

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

  1. i am an experienced pair trader and in my opinion the entry/exit arent nearly as important as trading the pair. the first time you put the pair on isnt when u make your money, its usaully the 2nd or 3rd time youve added to it. by trading the pair it can be 5 points against your first position and you could be up a few thousand in it. by trading it you improve your price. the market starts to sell off dump your long and buy it back later/cheaper and ride your short. i dont know how the rest of you pair trade but when i put on a pair i am always long the weak stock and short the strong one. you fight the trend. the pair wouldnt be a good price to put on if this werent so. look at fnm fre why do u think thats a good price right now? because fnm has been getting pounded. anyway gl all
    #51     Sep 23, 2002
  2. lescor


    What about trading the trend of a spread? From my limited pair trading experience and watching, it seems that you can get some great trends to follow. HD/LOW has been in a beutiful trend for weeks now. This would be the opposite of looking for convergence, but would seem to work too.
    #52     Sep 24, 2002
  3. Hi trendsetter,

    You're describing what the majority of pairs traders do: you find a correlated pair of stocks and trade it increasing the position with increasing deviation and decreasing it with reversion. This could and does work, but what happens if you continue to double down against the trend? Look at AMR/DAL. This was a nicely correlated pair until 2mo ago. If you doubled your position anywhere within 2 months you'd be flipping burgers now.

    I am trying to develop a different approach where you treat a pair as a unique occurrence, not a trading vehicle. You choose from hundreds of pairs today the ones that have the best odds to become profitable in the near term. Having well-defined entry and exit points will prevent you from blowing your capital on something like AMR/DAL.
    #53     Sep 24, 2002
  4. nitro


    This is a variation of a pair trade - you are simply playing the pair to "diverge."

    This is a perfectly good way to trade - I have noticed that some traders prefer convegence, others divergence. They may even both make money on the same trade being in it at the same time - they may even have bought and sold to each other! The exit is the difference for each, and the time frame...

    #54     Sep 24, 2002
  5. nitro


    This is the essence of the way I trade pairs.

    #55     Sep 24, 2002
  6. Pair trading works until it does'nt . As you gain success and experience in pair trading, you tend to double up , take more size as it strays from the mean and at the point that you think the rubber band is about to rebound back to the mean is usually your point of capitulation plus one more tick. If if reverts you make a killing BUT if the band breaks (witnes fnm/fre and HD/LOW ) you lose months worth of profits. The trick is the discipline to not be at that point of capitulation - to trade the pair and not be at the praying stage when you are +5000 / -5000 or whatever size you are comfy with. One day I will get to that point. Read up on Talebs book called "fooled by randomness' great point about strategies that work until they don't and secret is in knowing that it is not working and get out. Best of luck to the pairtraders out there.
    #56     Sep 24, 2002
  7. i agree gat trader, that is the trick make enough to cover your hits and still have a profit. find pairs with a small range most of the pairs i play have less than a 10 point range over 2 years. and i dont keep doubling up well i do but if i am getting crushed and i have my position up to say 10000/ - 10000 intraday i wont hold that amout over night unless i have a good reason. i may hold a few thousand and take the hit on the rest. i will make it back tommorow.
    #57     Sep 24, 2002
  8. At what point do you cut your losses if it keeps moving against you? Anyone who pair trades care to comment?
    #58     Sep 25, 2002
  9. When you get a call from the LLC main partner which usually means you gotta come up with more $ in your cap account. That is why it is so important to know your capitulation point and get rid of it before the band breaks OR use options as insurance.
    #59     Sep 25, 2002
  10. i think you have to decide what you are willing to risk. how much pain can u take. if there is news on either of your stocks that makes a difference. you should evaluate your position to the best of your ability. news is really the only thing that effects your pairs drastically. i remember i was short cof and long pvn i put the spread on at 18 then over a few days it went to 24. a few days later it came back to 18.5 and i took it all off. good thing
    #60     Sep 25, 2002