Once upon a time...and they lived happily ever after...whew
Pair Trading Strategy Journal
- Thread starter jonnysharp
- Start date
Once upon a time...and they lived happily ever after...whew
Hi Deucy28,
First of all I am amateur trader and very new to pairs trading so for pairs trading experience I am at level 1 - on a good day!
Point 1 - I have come to the conclusion that for me, statistically backed methods of trading seem to capture my interest and suit my style. I have an engineering background and like things that have mathematical and logical solutions. So, yes, I guess I am enthusiastic about pairs trading and treat it with a scientific approach. Certainly my back testing shows it to be a good way of trading.
Point 2 - Yes, I do expect the trades to be closed in short order and for me that is a week or so. I tend to get a bit stressed when they run on in the wrong direction for several weeks!
Point 3 - I am certainly using analytical software, Pair Trade Finder, and I am experimenting with different entry layers and exit points. The defaults do seem to work best when back tested.
In my case, all three conclusions fit with my approach to pairs trading. Unfortunately, I don't know about other pair traders, amongst my friends and family I am the only person trading rather than investing. Most look on it as gambling and I have an up-hill struggle convincing them otherwise but recently my Dad has achieved more capital gain than I have through his investing - humbug!
My current pairs trades are not making me happy, the loss on my currently active pairs has now wiped out all of the gains from my closed pairs. Some are starting to re-converge but I have been caught out by two trades, HPQ/Dell (not nice!) and CFN/STJ. I have learnt a bit more since entering these trades, I would probably have still taken HPQ/Dell but would't have taken CFN/STJ, I traded on the wrong side of the slope of the ratio.
And all of the Trades I didn't take are getting exit signals on PTF and all at a profit - its so frustrating!
First of all I am amateur trader and very new to pairs trading so for pairs trading experience I am at level 1 - on a good day!
Point 1 - I have come to the conclusion that for me, statistically backed methods of trading seem to capture my interest and suit my style. I have an engineering background and like things that have mathematical and logical solutions. So, yes, I guess I am enthusiastic about pairs trading and treat it with a scientific approach. Certainly my back testing shows it to be a good way of trading.
Point 2 - Yes, I do expect the trades to be closed in short order and for me that is a week or so. I tend to get a bit stressed when they run on in the wrong direction for several weeks!
Point 3 - I am certainly using analytical software, Pair Trade Finder, and I am experimenting with different entry layers and exit points. The defaults do seem to work best when back tested.
In my case, all three conclusions fit with my approach to pairs trading. Unfortunately, I don't know about other pair traders, amongst my friends and family I am the only person trading rather than investing. Most look on it as gambling and I have an up-hill struggle convincing them otherwise but recently my Dad has achieved more capital gain than I have through his investing - humbug!
My current pairs trades are not making me happy, the loss on my currently active pairs has now wiped out all of the gains from my closed pairs. Some are starting to re-converge but I have been caught out by two trades, HPQ/Dell (not nice!) and CFN/STJ. I have learnt a bit more since entering these trades, I would probably have still taken HPQ/Dell but would't have taken CFN/STJ, I traded on the wrong side of the slope of the ratio.
And all of the Trades I didn't take are getting exit signals on PTF and all at a profit - its so frustrating!
Hi JohnP1000,
One suggestion. Pairs trading, like many other trading styles that have a statistical edge, is simply a numbers game.
If you had a coin that was designed to come up heads 70% of the time, would you expect it to come up heads on the next flip or two? Of course not.
To make the stats bear out, you need to do lots of iterations. Keep your trading size very small so the the HPQ/Dell trades won't hurt so much and then place lots of those small trades to get the stats working on your side.
JohnR
One suggestion. Pairs trading, like many other trading styles that have a statistical edge, is simply a numbers game.
If you had a coin that was designed to come up heads 70% of the time, would you expect it to come up heads on the next flip or two? Of course not.
To make the stats bear out, you need to do lots of iterations. Keep your trading size very small so the the HPQ/Dell trades won't hurt so much and then place lots of those small trades to get the stats working on your side.
JohnR
Hi John P....
Of course the obvious difference between the coin flips and your population of trade possibilities is striking: (1) Trading all your possibilities with a guarantee from the fairy godmother 70% of your trades would be successful and 30% would not be, does not guarantee you to be net positive; for what if each unfavorable trade loses you 2.5 for each gain made ? (2) Or if 70% of your trades are guaranteed winners over the next 5 years: the first three years were disproportionately terrible and you know with certainty the next two years would be far, far more disproportionately excellent, but you become unable to trade after the first three months of those two years (you have to use your trading capital for a family emergency or you become disabled, or you get sent to prison or somewhere you cannot trade). (3) Or with each flip of the coin, how many events do you have to watch at one time vs how many plausible trades must you manage at once ?
Question: When you see your plausible trades, are you able to calibrate some as being much more probable of success than others ? Can you get a sense of relative magnitude of gain, particularly for some that appear to be strikingly excellent for a larger amount of gain ? Could you not increase your amount of capital significantly on a trade when being able to judge a relatively larger magnitude of gain ? I do that all the time with my style of pair trading. My base trade starts with a factor 1 multiple. If the trade appears to be unusually compelling, I will put on a factor 2 of base trade amount. If it appears to be a truly rare prospect, I put on a factor 3.
Hi deucy28,
Your concerns seem to revolve around a lack of faith in the statistical edge. With proper pair selection and execution, I believe there is an edge in pairs trading. Once I am convince of my method, I just want to do lots of occurrences keeping the trade size small so any loser or string of losers does not hurt too much.
I would not want to vary my trade size. I cannot predict which pairs trade will be better than another. If I had that skill I would use it more profitably elsewhere. I want the statistical edge to do the heavy lifting.
JohnR
Your concerns seem to revolve around a lack of faith in the statistical edge. With proper pair selection and execution, I believe there is an edge in pairs trading. Once I am convince of my method, I just want to do lots of occurrences keeping the trade size small so any loser or string of losers does not hurt too much.
I would not want to vary my trade size. I cannot predict which pairs trade will be better than another. If I had that skill I would use it more profitably elsewhere. I want the statistical edge to do the heavy lifting.
JohnR
JohnP
In addition to my question to you at my last post about varying size of initial trading capital per trade based on the magnitude of potential gain, another modality to pair trading is hugely important. I am not certain whether you aggressively apply this or not, because you said in your last post, in part....
".... I am experimenting with different entry layers and exit points."
That is not perfectly clear to me what that means. I have a measured benchmark by which I increase the capital to a trade proportionate to the degree it goes against me. Importantly, I check all clock positions before the aggressive run in: double check my charts, look for news, be aware of earnings reports, etc. Consider this which is rudimentary to my trading: If after due diligence and deliberation, I clear myself hot for escalating additional smash to the trade. If I affirm it was a good trade to begin with, the prospects have become that much more excellent now that the rubber band has stretched much more. John, when I read you suffering from unbooked losses while open in trades, I welcome them for myself when they occur: the odds have gone largely in my favor. At worse, I expect to do better than break even on the trade considering the cumulative net from layers, and at best, I expect respectable success. Let me direct you to some posts in the recent past.
(1) As a primer on adding layers: check out my post: (The link is designed to get you to the page, but may only get to a page that is close, so I gave you the dates and time of the post.) (My ET settings are such that 10 posts show up on one of my pages; if your setting is different, the link may not get you to exactly the right page for you.)
Forums âºâº Trading for a Living âºâº Trade Management âºâº I would like to discuss averaging down
deucy 28 on date 09-18-12 10:42 AM (I address Layering half way down this post.)
http://www.elitetrader.com/vb/showthread.php?s=&threadid=248511&perpage=10&pagenumber=8
(2) Examples of layering with trades / charts on on this thread that we are posting on now:
Forums âºâº Trading for a Living âºâº Journals âºâº Pair Trading Strategy Journal
09-19-12 05:08 PM Short CI and Long AET
http://www.elitetrader.com/vb/attachment.php?s=&postid=3631301
and
09-26-12 08:00 AM Short HON and Long BA
http://www.elitetrader.com/vb/attachment.php?s=&postid=3636948
JohnP........thank you for your response to my request to comment about the three take-aways I have gained from this multi-year thread. As a favor in return, I would be willing to look at your positions from MY perspective which would be a very different one from your use of the software. Just go to your account and then to your Private Messaging and let me know the symbols and their respectively being LONG or SHORT and START date and time of the trade. Of course, if you want to post that info here on this thread, you may get more responses. An alternate thought is you may rather let me know what trades you are CONTEMPLATING so we can compare notes with respect to their viability (Your software and my chart examination). I can post my results on this thread and others may wish to comment, too. Let me know if you don't want me to mention your name.
FWIW to you, my background and orientation to pair trading can be found on this thread using the link. At first blush, because our trading approach is different (vive la difference) my comments may not have chemistry for you. But just as elements of software and analytics have room in my mind, so may charting have room in yours. (My core is not technical analysis.)
In addition to my question to you at my last post about varying size of initial trading capital per trade based on the magnitude of potential gain, another modality to pair trading is hugely important. I am not certain whether you aggressively apply this or not, because you said in your last post, in part....
".... I am experimenting with different entry layers and exit points."
That is not perfectly clear to me what that means. I have a measured benchmark by which I increase the capital to a trade proportionate to the degree it goes against me. Importantly, I check all clock positions before the aggressive run in: double check my charts, look for news, be aware of earnings reports, etc. Consider this which is rudimentary to my trading: If after due diligence and deliberation, I clear myself hot for escalating additional smash to the trade. If I affirm it was a good trade to begin with, the prospects have become that much more excellent now that the rubber band has stretched much more. John, when I read you suffering from unbooked losses while open in trades, I welcome them for myself when they occur: the odds have gone largely in my favor. At worse, I expect to do better than break even on the trade considering the cumulative net from layers, and at best, I expect respectable success. Let me direct you to some posts in the recent past.
(1) As a primer on adding layers: check out my post: (The link is designed to get you to the page, but may only get to a page that is close, so I gave you the dates and time of the post.) (My ET settings are such that 10 posts show up on one of my pages; if your setting is different, the link may not get you to exactly the right page for you.)
Forums âºâº Trading for a Living âºâº Trade Management âºâº I would like to discuss averaging down
deucy 28 on date 09-18-12 10:42 AM (I address Layering half way down this post.)
http://www.elitetrader.com/vb/showthread.php?s=&threadid=248511&perpage=10&pagenumber=8
(2) Examples of layering with trades / charts on on this thread that we are posting on now:
Forums âºâº Trading for a Living âºâº Journals âºâº Pair Trading Strategy Journal
09-19-12 05:08 PM Short CI and Long AET
http://www.elitetrader.com/vb/attachment.php?s=&postid=3631301
and
09-26-12 08:00 AM Short HON and Long BA
http://www.elitetrader.com/vb/attachment.php?s=&postid=3636948
JohnP........thank you for your response to my request to comment about the three take-aways I have gained from this multi-year thread. As a favor in return, I would be willing to look at your positions from MY perspective which would be a very different one from your use of the software. Just go to your account and then to your Private Messaging and let me know the symbols and their respectively being LONG or SHORT and START date and time of the trade. Of course, if you want to post that info here on this thread, you may get more responses. An alternate thought is you may rather let me know what trades you are CONTEMPLATING so we can compare notes with respect to their viability (Your software and my chart examination). I can post my results on this thread and others may wish to comment, too. Let me know if you don't want me to mention your name.
FWIW to you, my background and orientation to pair trading can be found on this thread using the link. At first blush, because our trading approach is different (vive la difference) my comments may not have chemistry for you. But just as elements of software and analytics have room in my mind, so may charting have room in yours. (My core is not technical analysis.)
Hi johnr777,
Indeed, I AM a believer. Given enough trades, all the same committed amount of capital, the wind is at your back with a 70% potential for success. I was just pointing out the vagaries of that chance coming through in a manner you expect as each trade is challenged with the details I pointed out. Hint: I didn't itemize additional challenges that could occur infinitely more to trading compared to coin flipping. On the other hand, you might miss the catch after the flip and the coin falls into a street drain, or a gang member intercepts the coin while in the air !
I, too, am committed to belief in pair trading. It is not as sexy as other styles of trading. As described in a very recent post by one who I respect, that characterization is corroborated by explaining that it innately tends to be a relatively safer style trade with a 5% to 10% return at the end of the year. Of course us devotees hang on to the notion we will do better ! (Your approach of minimum capital devoted to trades will be an anchor, in my opinion in terms of rising above the 5% to 10%). BTW, I am not fixated on 5 to 10, but do believe low risk comes with low yield pair trading.
It would take experienced pairs traders making the same remark you do about not being able to know a really good potential gaining trade vs a mediocre one to make me believe that. I do not, though, use any software and cannot comment on limitations. But if there is that limitation in software that doesn't allow him to recognize a potentially, relatively excellent gain potential with a pair, his use of supplemental resources makes me intuitively believe he will sniff a good smelling one when it appears.
Finally, making equal capital commitments to every trade should you come to realize some trades do in fact have better potential would be a fool's errand. If the blackjack deck the dealer is holding has a disproportionate, excessive ratio of 10 cards, and I know that from my card counting, I will leave you in the dust comparing my winnings to yours after a year of me making larger-than-base bets. And if your resources in pairs trading compels you into a trade, and it goes south on you, will you not put on another layer of the trade at some pre-determined point ? The stretched rubber band in your open trade is the pair of Aces the dealer has just thrown you on the come-out deal. Yes, you will have to put your head on a swivel stick and check your 6 o'clock for variables that can bite you in the butt, but if the confidence was there in the initial opening of the trade, why wouldn't that confidence grow now ? This is your opportunity to neutralize a loss on the original stake, at a minimum, and make a wonderful trade when both levels go positive. And remember, you are with friends.......What goes on at Elite Trader stays at Elite Trader.
Hi Johnr777 and Deucy28,
I thank you both for your advice and interesting posts and yes, I agree that pairs trading is a statistical numbers game and the challenge is to get the odds on your side. My first trade was on the 25/09/2012 and I didn't place my second one until the 12/10/2012. Since then I have placed quite a few but my trading didn't really start until the 2nd week of October so I haven't really given enough time for many of my trades to work out.
Deucy, You mention adjusting trade size based upon the feel for the relative potential outcome of the trade. I know what you mean but I don't know that I am proficient enough to make those judgements at the moment but I am getting to visualise those trades that look promising and those that look very risky. At the moment, as I am in the learning phase, I am placing the smallest trades that I can through my spread betting account, usually 24p/point on the leg with the high stock price and the appropriate proportion on the other leg.
Your question regarding my experiments with layering and levels: I have been back testing with different standard deviation entry and exit points. I have settled on:
Layer 1: 2.7
Layer 2: 3.7
Layer 3: 4.7
And I exit at <= 1 sd.
These happen to be the defaults in PairTradeFinder and seem to give the optimum results when back testing. Although, I am not sure that PTF works properly when the SD is > 3.3 - I got some odd results when back testing.
Deucy, I have briefly read some of your past posts as suggested and I think we have a few things in common especially on the view of layering.
I will take you up on your offer of posting my trades for analysis, I am happy to take any criticism but would appreciate it if it is qualified in some way. I have no issue with my trades being made public - they may provide for some laughter and amusement!
Prior to posting my trades I will explain the criteria I am now using after making plenty of mistakes:-
1) Ratio to be flattish but a trending ratio is OK so long as I am trading in the direction of the slope of the ratio.
2) The P/E of the long stock to be less than the short stock
3) The Beta's to be similar
3) Cap > 500,000
4) No earnings reports within the next 6 weeks
5) 2 period RSI of long stock <20 and short stock >70
6) Same sector and market
I am also looking at Bollinger bands to see if they can help with entry points and also previous trade durations to see if previous duration can be used to determine a time stop on the current trade.
Anyway here are my winning trades to date with entry date:
HIW/HTS 12/10/12
DGX/PFE 18/10/12
PLL/SWK 18/10/12
AGNC/KIM 18/10/12
PLD/HBAN 19/10/12
UPS/FDX 31/10/12
BA/GD 01/11/12
KIM/WRI 08/11/12
HTS/SPG 08/11/12
MAA/NLY 08/11/12
And these are the ones that are currently active but not doing too well:-
BRE/CLP 15/11/12
BAX/COV 13/11/12
ALGN/ZMH 13/11/12
CFN/STJ 12/11/12 and then layer 2 - I didn't write down the date-ugh!
NLY/SNH 12/11/12
AMAT/LLTC 09/11/12
HPQ/DELL 09/11/12 and then layer 2 on 21/11/12
ATI/SEE 01/11/12
DHR/ROP 19/10/12
KEY/MCO 18/10/12
MRO/NBR 25/09/12
Please don't feel obliged to comment on all of them, I am sure that you have plenty of other things you prefer to do but any comments from you will be appreciated.
Deucy, you posted a pair HOT/HST a short while back and I checked it against my criteria and it doesn't signal a trade for me. I think that you have mentioned HOT/HST in previous posts so I assume that it's a pair that you have had success with. I will take another look at it later.
John
I thank you both for your advice and interesting posts and yes, I agree that pairs trading is a statistical numbers game and the challenge is to get the odds on your side. My first trade was on the 25/09/2012 and I didn't place my second one until the 12/10/2012. Since then I have placed quite a few but my trading didn't really start until the 2nd week of October so I haven't really given enough time for many of my trades to work out.
Deucy, You mention adjusting trade size based upon the feel for the relative potential outcome of the trade. I know what you mean but I don't know that I am proficient enough to make those judgements at the moment but I am getting to visualise those trades that look promising and those that look very risky. At the moment, as I am in the learning phase, I am placing the smallest trades that I can through my spread betting account, usually 24p/point on the leg with the high stock price and the appropriate proportion on the other leg.
Your question regarding my experiments with layering and levels: I have been back testing with different standard deviation entry and exit points. I have settled on:
Layer 1: 2.7
Layer 2: 3.7
Layer 3: 4.7
And I exit at <= 1 sd.
These happen to be the defaults in PairTradeFinder and seem to give the optimum results when back testing. Although, I am not sure that PTF works properly when the SD is > 3.3 - I got some odd results when back testing.
Deucy, I have briefly read some of your past posts as suggested and I think we have a few things in common especially on the view of layering.
I will take you up on your offer of posting my trades for analysis, I am happy to take any criticism but would appreciate it if it is qualified in some way. I have no issue with my trades being made public - they may provide for some laughter and amusement!
Prior to posting my trades I will explain the criteria I am now using after making plenty of mistakes:-
1) Ratio to be flattish but a trending ratio is OK so long as I am trading in the direction of the slope of the ratio.
2) The P/E of the long stock to be less than the short stock
3) The Beta's to be similar
3) Cap > 500,000
4) No earnings reports within the next 6 weeks
5) 2 period RSI of long stock <20 and short stock >70
6) Same sector and market
I am also looking at Bollinger bands to see if they can help with entry points and also previous trade durations to see if previous duration can be used to determine a time stop on the current trade.
Anyway here are my winning trades to date with entry date:
HIW/HTS 12/10/12
DGX/PFE 18/10/12
PLL/SWK 18/10/12
AGNC/KIM 18/10/12
PLD/HBAN 19/10/12
UPS/FDX 31/10/12
BA/GD 01/11/12
KIM/WRI 08/11/12
HTS/SPG 08/11/12
MAA/NLY 08/11/12
And these are the ones that are currently active but not doing too well:-
BRE/CLP 15/11/12
BAX/COV 13/11/12
ALGN/ZMH 13/11/12
CFN/STJ 12/11/12 and then layer 2 - I didn't write down the date-ugh!
NLY/SNH 12/11/12
AMAT/LLTC 09/11/12
HPQ/DELL 09/11/12 and then layer 2 on 21/11/12
ATI/SEE 01/11/12
DHR/ROP 19/10/12
KEY/MCO 18/10/12
MRO/NBR 25/09/12
Please don't feel obliged to comment on all of them, I am sure that you have plenty of other things you prefer to do but any comments from you will be appreciated.
Deucy, you posted a pair HOT/HST a short while back and I checked it against my criteria and it doesn't signal a trade for me. I think that you have mentioned HOT/HST in previous posts so I assume that it's a pair that you have had success with. I will take another look at it later.
John
Hi Deucy,
I forgot to say that I am more than happy to post my trades on this thread for comment and discussion, it is likely to help me with my trading but it may also help others who are just following the thread.
I will see if I have any candidates on Monday and if there are I shall post them with my thoughts and reasoning for the potential trade.
John
I forgot to say that I am more than happy to post my trades on this thread for comment and discussion, it is likely to help me with my trading but it may also help others who are just following the thread.
I will see if I have any candidates on Monday and if there are I shall post them with my thoughts and reasoning for the potential trade.
John