Quote from waltbx:
Here is what I did. I'm grateful for the guys who know much more than I do for sharing. I learned from them, especially Jonny.
I have read each and every one of the posts listed in this journal, and copied notes into a word processer to use as a training guide. I'm treating it as a business and am being very serious about it. I ask questions on the forum after I have worked unsuccessfully to find my answer.
My Pair Trade Finder settings are the default settings, except my trade size setting is $2500 (Long+Short = $5000 total). My account size was a little larger than $25K now up to almost $30K, and I use the margin provided by my broker, IB. I have my layers set to 2.00, 2.20, 2,40, etc.
I studied the graphs of the trades Jonny put on, and studied his loosers. What was the commonality in the big losses? What did the graphs show that was in common in the losses?
To find Jonny's spreadsheet of his trades, go through the posts to find where he posted his Excel spreadsheet. Study his trades, and look up the graphs in Pair Trade Finder. As Jonny posts his trades in this Journal, I put each of them in the spreadsheet. I study the losses.
Some thoughts on what pairs to choose. Some people on this thread have said they aren't concerned much about the past profit history of specific pairs. I don't agree. (Keep in mind that many of them have much more experience than I have, and you should weigh their advice heavier than mine.) It is my belief that if we are to look historically at correlation of stocks in a pair, it is equally valid to look at profit history of the pair. After all, profit is why I'm in the game. If I have a choice between a pair averaging $35 profit over the past year, and one averaging $200, I'll choose the $200 pair. So I load my stocks, then PT finds all the pairs, and I choose the ones averaging $200 or more and with a correlation of 60% or better. My trade size is $2500 so if you go with a $10,000 trade size, you would look for pairs with an average profit 4x larger, or $800 or more. I don't tie my money up with smaller potential profit.
When I discovered what I think is the key to knowing if a good pair will bring a profit today, I was ecstatic. I was looking at Jonny's trades and studying the graphs. You must do this. It will sink in better if you do this yourself, I believe. I saw the correlation between his loosing trades and the graph for those pairs. Most of them were trending pairs.
Remember, that to be profitable, the ratio must drop below where it is today (that is if the ratio is above the mean today -- or go up if below the mean). And remember too, that this is called Mean Reversion pair trading. We look for pairs with ratios that have diverged from the mean, and we are expecting the ratio to revert back to the mean. But if, while we wait, the ratio continues to rise, over days it will drag the mean up with it. Losses occur when the daily ratio finally meets the mean, but does it above the entry ratio. So, the key is to study the Ratio Chart and pass on those pairs where the ratios have little chance of meeting the Mean Average line at a point where profit can be made. ie: don't trade pairs with strong trending graphs. Don't bother with "iffy" pairs.
Do not fail to check for news. Any news that affects one stock in the pair, but not the other is problematic. Earning's reports coming in the next two weeks are a possible problem.
I use a spread sheet to calculate an estimated profit % using the present ratio and my conservative estimate of where the ratio will be when it meets the Mean, determined from the ratio chart in PT. I choose only those pairs with an potential profit of 5% or more. I use this formula: (Expected ratio less today's ratio) / (today's ratio) x 0.5 as a percentage. This has been VERY helpful in making choices. Some pairs that have enter-the-trade signals have had potentials of 10%, some less than 1%.
Before I get a signal to close, I'll set a stop loss to protect profits if one side is showing good profit. I'd rather take a good present profit, than risk losing it for possible future gain. Perhaps I'm wrong. When I get a signal to close the trade, I'll close out the losing side, but let the profitable side run, keeping a trailing stop loss to protect my profits.
Jonny spends an hour studying the pairs, and trades once a day, at closing. I'm excited and having fun, so I spend my morning (I'm on the west coast USA) at the computer studying the trades and playing the "game." Personal choice. Eventually, I'll probably shift to what Jonny is doing, and do other things with my day.
I haven't tried to factor RSI into the mix. Maybe someone with experience can tell me how RSI has been important to them. I haven't factored in spread either. I'd guess that if the spread were decreasing, that would be a good sign.
Works for me. So far.
Walt B
