I have never held myself out as any sort of learned person when it comes to equity pairs and spread combinations. I have and continue to hold myself out as being a good futures spread trader with a long resume of credentials in that field and a consultant to qualified professionals specifically in the area of futures spreads. My entry system and methodologies have been expressly designed by me to swing trade futures spread combinations based on price action. My clients report to me consistently good results specifically in the arena of swing trading futures spread combinations - inter market and intra market. Although I used to do a hell of a lot of it with David Ellis's Group in Glenview about a decade ago, I personally think that day trading or scalping futures spreads is a tough game. I think the best use of capital is to carry a portfolio of futures spreads because the capitalization is usually so cheap as compared to other futures margins, and for the diversification. Every prospect that I contract with and take on as a client wants to swing trade futures spreads, and that is my core competency.
I will fund an IB account in the near future for the express purpose of trading some equity spread combinations and gaining some experience in that regard. If it's profitable and consistent, I'll offer it to clients. I will check with my two HF equity analyst clients to make sure that I'm using the correct hedge ratios in terms of volatility and notional value.
Having said all that, I do have clients who use my system to successfully trade equity pairs and equity spread combinations to good effect( for which it was not designed and for which I freely admit I am a rank piker ). What I do know about equity pairs and equity spread combinations comes from clients offering up observations and lessons to me - I've had several Bright traders come to me wanting to learn how to spread trade futures, I've had a few HF relative value equity analysts as clients, and a couple equity options traders as clients.
We collectively have weekly group webinars on "go to meeting", where we all review and dissect each others' live trades and paper trades and SIM trades. Lately I have been seeing more and more equity spread trades from clients using what I had designed for futures trading. ( btw, I record those webinars and distribute them to clients. For new clients, I download all the historical webinars to a remote secure server in compressed format for their download and use. I have been told it takes a couple weeks to get through them all ! )
So, without infringing on their specific IP, I will share some general observations I have gleaned from them. Again, this is expertise I have pilfered from clients and freely admit it. Very general and may or may not be useful:
1. The traditional approach to equity pairs trading as originally championed by MS in the 1980's is largely ineffective from what I have been told. ( Bright clients ) This method is to traditionally find statistical highly correlated equity pairs and fade what you model as one sigma moves in your time frame of interest. Which could be seconds or days or weeks or months. The trader would add at two sigma typically. I am told that these days there's just too much heat and drawdown for this to be effective. ( again, secondhand generalizations from clients, so take it FWIW )
2. I have been advised to not trade equity pairs, or to scale way back on size, during earnings season.
3. I have been told to choose equity combinations with similar market caps and within the same industry sector.
4. I have been advised by the HF analyst types that they tend to model in simple price ratios ( which is different than the hedged traded position ), and that they check for cointegration and delta directionality with the underlying components and the broad market ( random example below for illustrative purposes, I am not holding this out as a trade idea per se ).
5. I see alot of relative value plays based upon stars versus dogs. These are traded with the trend. For the longest time a few years ago, IBM/HPQ, VZ/S, XOM/BP ( oil spill ) seemed to be good examples.
6. I see relative value plays where the entire market was taking a huge shit ( esp. during 2008 ), but equity relative value plays pitting defensive stocks versus broad market ETFs was a fave. ( like CPB/SPY or MCD/SPY )
So, I will open an account with IB and trade some equity spread combinations for myself live, and in the same general vein as I swing trade futures spreads, and see what comes of it. The equity spread combinations I see from clients appear to trend very well, and it was obvious that choosing the components was the biggest deal. Most of the equity spreads I have modeled quite frankly I wouldn't know what the hell to do with them. But after several hours of work, I do manage to find one or two that trend well and that do not appear to be terribly delta directional with the broad market. Which is exactly what I look for in a futures spread come to think of it. I might also use ATM options in lieu of equity shares.
I will fund an IB account in the near future for the express purpose of trading some equity spread combinations and gaining some experience in that regard. If it's profitable and consistent, I'll offer it to clients. I will check with my two HF equity analyst clients to make sure that I'm using the correct hedge ratios in terms of volatility and notional value.
Having said all that, I do have clients who use my system to successfully trade equity pairs and equity spread combinations to good effect( for which it was not designed and for which I freely admit I am a rank piker ). What I do know about equity pairs and equity spread combinations comes from clients offering up observations and lessons to me - I've had several Bright traders come to me wanting to learn how to spread trade futures, I've had a few HF relative value equity analysts as clients, and a couple equity options traders as clients.
We collectively have weekly group webinars on "go to meeting", where we all review and dissect each others' live trades and paper trades and SIM trades. Lately I have been seeing more and more equity spread trades from clients using what I had designed for futures trading. ( btw, I record those webinars and distribute them to clients. For new clients, I download all the historical webinars to a remote secure server in compressed format for their download and use. I have been told it takes a couple weeks to get through them all ! )
So, without infringing on their specific IP, I will share some general observations I have gleaned from them. Again, this is expertise I have pilfered from clients and freely admit it. Very general and may or may not be useful:
1. The traditional approach to equity pairs trading as originally championed by MS in the 1980's is largely ineffective from what I have been told. ( Bright clients ) This method is to traditionally find statistical highly correlated equity pairs and fade what you model as one sigma moves in your time frame of interest. Which could be seconds or days or weeks or months. The trader would add at two sigma typically. I am told that these days there's just too much heat and drawdown for this to be effective. ( again, secondhand generalizations from clients, so take it FWIW )
2. I have been advised to not trade equity pairs, or to scale way back on size, during earnings season.
3. I have been told to choose equity combinations with similar market caps and within the same industry sector.
4. I have been advised by the HF analyst types that they tend to model in simple price ratios ( which is different than the hedged traded position ), and that they check for cointegration and delta directionality with the underlying components and the broad market ( random example below for illustrative purposes, I am not holding this out as a trade idea per se ).
5. I see alot of relative value plays based upon stars versus dogs. These are traded with the trend. For the longest time a few years ago, IBM/HPQ, VZ/S, XOM/BP ( oil spill ) seemed to be good examples.
6. I see relative value plays where the entire market was taking a huge shit ( esp. during 2008 ), but equity relative value plays pitting defensive stocks versus broad market ETFs was a fave. ( like CPB/SPY or MCD/SPY )
So, I will open an account with IB and trade some equity spread combinations for myself live, and in the same general vein as I swing trade futures spreads, and see what comes of it. The equity spread combinations I see from clients appear to trend very well, and it was obvious that choosing the components was the biggest deal. Most of the equity spreads I have modeled quite frankly I wouldn't know what the hell to do with them. But after several hours of work, I do manage to find one or two that trend well and that do not appear to be terribly delta directional with the broad market. Which is exactly what I look for in a futures spread come to think of it. I might also use ATM options in lieu of equity shares.