Pair Trading Strategy Journal

Quote from Vespasian:

Goldman Spread

Could some of you more experienced pairs traders share with me a scenario like MS / GS spread after the day of the charges where laid?

Curious to know what one does in such a situation if you had that trade on.
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There are some reasons I can think of for why if you were holding the position on MS/GS you would want to exit once the news got out, whether you were short or long the pair.

1. The relationship between the pair is broken because of extraordinary news. You could rightly assume that more news is expected to come out in the days after of the announcement, whether for GS or against. If you hold on to the pair, what you are essentially doing is long or short GS. The other side of the pair isnt really doing much. Think about it, any significant news will snap the stock up 10% or further down another 10%. You are not really pairs trading anymore if you hold a pair when it has structurally changed.

2. The weighting would have changed significantly. So now you have to go and re-weight the pair. In addition the beta may now be very different as GS may be very volitile.

3. If you are pairs trading then you should trade them as a pair. If you want to trade mean reversion of stocks when they react or overreact to earnings or news, then that is something entirely different, which can be a profitable strategy in its own right, but its not a good pair strategy to continue to hold the pair.
 
My strength and proficiency has been and continues to be with interest rate and commodity spreads like currencies, softs, metals and energy - futures, bilateral OTC, and cash. So, I do not present myself as a pairs expert per se. Having said that, there are some ET members who actively trade equity pairs and participate in this thread who performed extensive due diligence on me and subsequently hired me to transfer some of my futures spread trading expertise into their own equity pairs trading strategies.

I wanted to share some initial perceptions:

1. I am not at all convinced that CFD with a holding period measured in days and weeks offers the best risk/reward skew for trading equity pairs. My modeling shows that indeed has been the case for the past 24 to 32 months. If a trader wants to continue to pursue this strategy, his use of capital would be much better served using ATM options to book the gamma while selling off the vega component. For example, buying $10k worth of IBM ATM calls and selling $10K worth of HPQ ATM calls.

2. I am teaching my new equity pairs clients to apply my divergence modeling and entry/exit strategies to intraday trading. I have some very unique (I think) trade setups that have worked for many years in futures. I do model and make substantial allowances for mean reverting or trending markets. i use MatLab and Statistica to test for cointegration and correlation in one minute increment tic data time series. I prefer to choose pairs within the same industrial sector, same fundamental drivers for retained earnings, and as close a market cap as possible - so, having said that, divergence rules.
 
Action for today:

Opened 3 new pairs few minutes ago:

Shorted BCR @ 84.41
Bought BDX @ 76.42

Bought AMR @ 7.39
Shorted LCC @ 6.85

Shorted DFG @ 27.63
Bought MET @ 44.74

M.
 
Opened

8K
Long CNA @ 27.73
Short AFG @ 29.50

6.5K
Long ctrn @ 33.63
Short FL @ 15.94


Closed

DRI -TXRH 3.2 % profit
KBH-MHO 1.75 % profit
NBL-EPD 5.75 % profit
 
Quote from Magnas:

04/27/2010 action:

Closed KIM-WRI for gain 0,81%
Closed AFG-ALL for gain 4,06%

Opened new pair:

Bought BMY @ 24.27
Shorted WX @ 19.54

M.
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First, thanks for sharing in this thread.

About BMY / WX...

WX has a pending merger that values it at ~ $21.25. That is the reason for the big move in the pair. I can't see the short side of this going down much. Are you expecting the deal to fall through?
 
Trom,

First – I am beginner with pair trading, so please take my posts as thoughts of someone who is learning.

You are right - I didnt pay too much attention to fundaments, so I didnt know about the merger. So far, I have been trading the pairs just from statistical view, but see I should start looking at fundaments too.

Will be interesting to observe how the pair is behaving in such a situation (so far it has been +1% gain since I entered).

Thank you for pointing me to the fundamental information.

M.




Quote from trom:

First, thanks for sharing in this thread.

About BMY / WX...

WX has a pending merger that values it at ~ $21.25. That is the reason for the big move in the pair. I can't see the short side of this going down much. Are you expecting the deal to fall through?
More...
 
Hi all,

First of all Johnny, amazing effort from your side.

I went through the first 100 pages on this journal but i couldn't find out one thing.

How do you distribute your capital among your pairs?

For example: Lets say i have $ 100,000 with me and depending upon some criteria i get 2 pairs each day with holding period of 6-8 days. Now if i put $1000 on each side, in the first 6 days i have $24000 of my money blocked ( assuming none of them converged). So my account is showing $66000 as resting capital.

On the 7th day my first pair converged and i got my 2000 back with some P/L. Now on the account shows $68000.

My question is, how do i put the optimal money per pair so that i am utilizing my resting capital.

What i mean on the 7th day i have $68000 in my account and i want to use it fully in the future trades, something similar to optimal f ...but then i am not sure.

Can any one tell me how can i do that?

Thanks all.
 
Quote from vipin.kumar05:

Hi all,

First of all Johnny, amazing effort from your side.

I went through the first 100 pages on this journal but i couldn't find out one thing.

How do you distribute your capital among your pairs?

For example: Lets say i have $ 100,000 with me and depending upon some criteria i get 2 pairs each day with holding period of 6-8 days. Now if i put $1000 on each side, in the first 6 days i have $24000 of my money blocked ( assuming none of them converged). So my account is showing $66000 as resting capital.

On the 7th day my first pair converged and i got my 2000 back with some P/L. Now on the account shows $68000.

My question is, how do i put the optimal money per pair so that i am utilizing my resting capital.

What i mean on the 7th day i have $68000 in my account and i want to use it fully in the future trades, something similar to optimal f ...but then i am not sure.

Can any one tell me how can i do that?

Thanks all.
More...

Take the trades as you see them if you have enough BP, if your getting low on BP and are maxing yourself out, become more picky in your selection process... Similary if you have a lot of remaining BP double up your positions.

Just becareful because you might get involved in some thinner stocks especially towards the middle of the trading day and if your putting on some fairly big positions you can definately push the stock.
 
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