Pair Trading

Does anyone on this forum engage in pair trading? For the uninititated, pair trading involves buying a stock that looks good and selling a stock that doesnt look so good. You would expect the stock that you are buying to perform better than the stock your are selling. It is a lot for more detailed than how I have just described it (using a lots of statistical and econometric techniques).
Anyone out there??

That sound more like a hedge trade to me.

Although I am a trend follower and would prefer picking strongly trending stocks in an uptrend to go long, I have never thought about this strategy. Sound interesting. Looking forward towards more input on this.

__________________
Best Wishes!

Traderji

www.Traderji.com

Hello Ivan,
Though at the same time,some a times I m long in a particular scrip,and short in some other,in intraday,but have not thought of a comparative analysis---in this aspect---Also---is it allowed to carry forward the shorts in a scrip over a particular time frame---unless u r trading in F&O?---Waiting to hear a lot from u and other knowledgables in this aspect---
Regards ,
joy_mitali

I have done some statistical analysis (correlations) using pairs but have not proceeded further because I could not find more information on how to select pairs. Also, since we cannot sell short in the Indian markets how can we sell a stock? Do you have or can you point me to any resources on pairs trading? especially on selection of pairs. Whatever info I have about pairs selection I got it from EliteTrader.com forums.

--SwingTrader

Hi SwingTrader,
We can carry out the trades on the futures segment, instead of the cash segment. So we also need a smaller cash outlay (for margin). However, we are restricted to only those stocks that are present in the F&O segment.
I have gone thru' Trading Pairs by Mark Whistler. Its pretty elementary, but then you do get some ideas to play around with, and tweak to your needs.
Pairs Trading by Ganapathy Vidyamurthy is pretty advanced, and not too helpful with the praticalities of pairs trading.

Hi Ivanboesky:

I have done a lot of work on pair trading based on my work on FX pair trading (i.e when you buy dollar you must sell another currency against it - this seems obvious!) - but then I took the work further and went on to identify as to which particular currency against dollar would yield me the best r/r and probability of win/loss and I developed a 3-D matrix which helped me identify three best probabilities to trade against the dollar.

I took this work further and did similar work on US and UK stocks (where shorting of stocks is permitted) and some major stock indices. This I classified as follows:

1) Sectoral pair trading - where one buys and sells stocks in the same sector.

2) Intersectoral pair trading - where one buys a stock (preferably with the most bullish sentiment) in a sector that is turning bullish and selling a stock (preferably with the most bearish sentiment) in a sector that is turning bearish.

3) Intermarket index pair trading with a currency overlay - where one buys an index of a market with a bullish potential and a bullish currency scenario and sells an index with a bearish potential and a bearish to neutral currency scenario.

I have found that the returns are quite smooth and when coupled with currency overlay sometimes quite extra ordinary - because you get the extra rewards from appreciating currency.

Although I have not done any work on stock futures I would imagine that atleast one would be able to short the stocks quite easily.

Pair trading is fun and intellectually very stimulating and challenging and also requires fair amount of work but can be very rewarding. The best part is that you have very few rivals -especially when you combine currency overlay with pair trading not even some of the world's biggest banks or fund management houses have traders with that sort of capability. Because they just cannot think laterally!

Some Hedge funds do long/short investing but the currency overlay is still missing from their models.

I would say worth investigating - if you have interest and are prepared to allocate time to it!

Regards

Nautilus.

hi Nautilus,
Grt to hear from u----Ur words---and ur experiences in trading are truely amazing---Already I have started my studies on Pair Trading---If u can give a detailed description on the 3D matrix u have developed--or some sources----I will try to simulate it---
I have recently started the work of isolating datas of all scrips ---on the basis of diff indicators---Its 80% complete---Its the work for developing a trading system---
Maybe---a few yrs hence-(or maybe much before)---I will try to incorporate all the tricks ---I m learning from u and WasteJ--My hats down to u both---as well as to Ivan Boresky for many an interesting threads in this forum--
Regards,
joy_mitali

Hi Joy:

Its good to hear that you have started work on pair trading and making good progress. I think you may achieve it much quicker than I did ( I started work on the old IBM 8086 PC which was very slow (8bit) and it would take ages - then I progressed to faster processors and the work got faster and finally when Sun Solaris work station became available I moved on to it and the work simply flew! - Thats another story.

Coming back to your question on 3-D matrix, I have tried to describe it in as great a detail as possible, and simplified it so that interested members of the forum may be able to learn and improve upon the concept and eventually teach me further. At the risk of being boring I have made the explanation as detailed as possible and in some cases slightly repetitive - and I apologise for that.

I have created a simple 2-D currency matrix as below with some numbers incorporated into (it is these numbers that changes it into a 3-D matrix):

3-D ACTIVE CURRENCY MATRIX
USD GBP EUR CHF JPY NOK SEK CAD AUD NZD SGD

USD 0 2 3 4 5 2 4 5 6 7 2

GBP 0 2 4 7 3 3 5 5 5 2

EUR 0 1 8 3 2 6 6 7 2

CHF 0 7 2 2 5 5 5 1

JPY 0 5 6 3 2 2 3

NOK 0 2 5 4 4 2

SEK 0 4 3 3 2

CAD 0 2 2 4

AUD 0 1 3

NZD 0 2

SGD 0

Lets analyse the first row of this matrix labelled USD and let me explain what these numbers mean. You would notice these numbers are different for different currency pairs and for some pairs they are similar.

For Gbp/Usd the number is 2
For Eur/Usd the number is 3
For Usd/Chf the number is 4
For Usd/Jpy the number is 5
For Usd/Nok the number is 2
For Usd/Sek the number is 4
For Usd/Cad the number is 5
For Usd/Aud the number is 6
For Usd/Nzd the number is 7
For Usd/Sgd the number is 2

These numbers represent the risk reward ratios that I have talked about and explained in one of my previous postings under FX titled "FX Trading Recommendation".

These numbers represent these risk reward ratios and they tell us the top three pairs for trading in this matrix against Usd will be Nzd (7) Aud (6) and Jpy or Cad both with the r/r of (5).

I have copied part of this particular thread for ease of reference below.

2) Risk Analysis: I choose a logical stop-loss based on Hourly charts. This involves studying 1 and 2 hourly charts and looking for "inside and narrow" (I&N) bar patterns. If I see a compression of bars which are also I&N then I look for the high of the largest bar and determine my "Risk" ie. stop-loss. In the case of Eur/Usd I had determined a risk of 0.0060 basis points based on above analysis so the stop-loss was placed at 1.2580 and my entry point was determined as 1.2520.

3) Reward Analysis: I look for the most recent swing's "highest high" in the EUR/USD case it occured on 2/9/05 at 1.2589 and I look for that swing's "lowest low" again in case of EUR/USD it occured on 19/8/05 at 1.2126.

Calculation of reward: (1.2589-1.2126)x 0.75 = 0.0347
Reward objective = (1.2589 - 0.0347) = 1.2242 ( I have rounded it off to 1.2250 on the higher side) this is also my objective.

Reward = 1.2520 - 1.2250 = 0.0270 basis points.

When you go long you perform the reverse calculation and add the 75% of the (high-low) to the low.

4) Calculation of risk (0.0060) reward (0.0270) ratio = 0.0270/0.0060 = 4.5

This idea was then applied to different stocks/ sectors and indices as refered to in my previous post.

Hope this helps.

Regards

Nautilus

Ps: Sorry the numbers are not evenly spaced in the matrix - but I am sure you can figure it out. For a visual presentation try and put these numbers in Excel and create a 3-D graphical presentation and you would get a visual representation of what I am trying to say - may be you can post it on this forum (use different colours for different currencies)!

You All look Super Heros to Me......................

Satya

Thanks Ivan for the info on books. Nautilus, thanks for the info.

--SwingTrader