Quote from yobo:
T
Here's a clip from an academic paper regarding pair trades and returns:
Abstract: This paper examines the impact of accounting information events (i.e., earnings announcements and analystsâ earnings forecasts) on the profitability of a pairs trading strategy proposed by Gatev et al. (2006). Using a portfolio of U.S. stock pairs between 1981 and 2006, we find that pairs trades are frequently triggered around accounting information events.
"More importantly, we find that pairs positions opened after accounting events are significantly less profitable than pairs positions opened in non-event periods. Furthermore, we find that incremental excess returns can be achieved by delaying the closing of a pairs position until after accounting information events."
Overall, our results suggest that drift in stock prices following earnings announcements and analystsâ earnings forecasts is a significant factor affecting the profitability of pairs trades.
Here's the full link:
http://management.bu.edu/academics/...ocki-PairsTradingAndAccountingInformation.pdf
The study actually seems to indicate that its best to open the pair before an event such as earnings and then to close out afterwords. This is opposite of what you are suggesting?
-------
Thanks for your feedback. The only real concern I have is that based on fundamental valuations I'd prefer to be long cvx and short xom, but the spread indicated otherwise so I went for it.
Live and learn.
First - you are doing well by experimenting and keeping the size small. Very commendable.
However, in the true spirit of experimentation - you must ask yourself "Is what I am doing right - and if so why do I think I am right?" as opposed to "This must be right because I am doing it"
You seem to be doing more of the former vs. the latter - although I am not sure I agree with some of your key conclusions.
Re: The study - I think I am familiar with it. If not this particular one, then others that have similar conclusions.
What is missing in your post is your criteria for being long XOM vs. CVX.
And, also, the criteria the study uses to pick the long vs. the short (I won't have time to look at the link and read for the specific criteria used in the study until after the close).
Many of these studies identify some fundamentally "expensive stock" via P/E or some other measure(s) vs. a "cheap" stock via the same metric or set of metrics.
The theory is that the high fliers fall harder when they miss vs. the rallies they tend to have when they beat. And the downtrodden rally harder when they beat vs. when they have missed for the third time in a row.
So to capture that - you would have to hold through earnings.
I have a lot of respect for academic studies and find them helpful. But they have a difficult time capturing the nuances of intraday and relatively high frequency short-term trading. Many of these studies are kind of "buy(or short) and hold" from one quarter to the next based on the criteria being studied.
From a pure price action perspective, there are tons of opportunities for trading between the quarterly releases. It is difficult for these studies to capture that dynamic. Also, the nuance of adding layers, how wide or how narrow, for how much profit, etc. - is rarely, if ever, addressed.
To your other question, yes I trade pairs - but I am not a big fan of intra-industry mean reversion. To me, picking the long vs. the short with XOM vs. CVX is like being paid to tell which Olsen twin is Ashley or Kate from a distance. Possible? Sure. But identifying Hulk Hogan vs. Paula Abdul from a distance is a lot easier, IMO.
So I specifically look for a security that will that will outperform another security.
Back to your study (or at least the ones that I am familiar with) - I think the difference in the "cheap vs. expensive" metrics were pretty significant between the longs and the shorts. I haven't looked at the fundamentals of XOM or CVX - but I would be surprised if they are that radically different. So the "edge" of being short a high flyer vs. being long a downtrodden stock may not be there in this case.
Anyway, there are 1,000 ways to skin the pair trading cat. As with trading in general, the key is to find an approach that woks well with your personality and your resources.
Good Luck.
