What to do with equity pair trades when a stock appears in multiple pairs

Discussion in 'Trading' started by purejimcn, Aug 23, 2010.

  1. purejimcn


    Hi all, I have searched the forum but haven't found anything that helps with my problem.

    So here goes.

    I am trying to setup pairs trading strategies with equities but on the final hurdle I seem to have run into a problem I can't solve. The problem is that one stock would come up into multiple pairs. For example the pairs I have would be say stocks

    1) long A vs short B
    2) long A vs short C
    3) long A vs short D
    4) long E vs short A
    5) long F vs short A

    So with stock A being in all the pairs is it common practice just to trade all the pairs? If I trade the first 3 pairs then it would be like taking a triple long position on stock A which seems very risky if stock A takes me into the red. In this case do I trade all 3 pairs (and treat them independently) or is there a way of picking 1 out of the 3 pairs to trade that I can use consistently in the future?

    Also if say I trade pair 1 then trade the pair 4 I would end up just having effectively "long E vs short B" while incurring double transaction costs. In this case do I still treat the pairs independently and trade them separately or does it make more sense to trade "long E vs short B"? If so then how can I choose between pair 4 and pair 5?

    In my back testing I treated everything independently but in practice this problem is bugging me. It would be greatly appreciated if anyone can share their experiences with me. Any thoughts are also welcome.

    Thank you all in advance