# New pair trade - Long RIO/Short BHP



## Pairs Trader (1 December 2008)

Hi all, thought I would take a chance and make a trade in front of everyone, im long RIO this morning from 43.69 and short BHP from 29.72 as I think it has over reacted from the aborted takeover news as this pair is over 3 standard deviations from its mean. Will scale into more if I can lower my cost average, looking to exit over the next several days, will advise when.


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## julius (1 December 2008)

*Re: New pair trade - Long RIO / Short BHP*



Pairs Trader said:


> as this pair is over 3 standard deviations from its mean.




Which mean are you talking about ?


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## Pairs Trader (1 December 2008)

*Re: New pair trade - Long RIO / Short BHP*

the rolling relationship average


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## julius (1 December 2008)

*Re: New pair trade - Long RIO / Short BHP*

Is this similar to correlation ?


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## Pairs Trader (1 December 2008)

*Re: New pair trade - Long RIO / Short BHP*

no correlation is measuring the strength of the relationship between two stocks, for example the current correlation reading on BHP/RIO is 96.90% which means they are almost in lockstep with each other. the rolling mean is the numerical representation of the day to day relationship between BHP & RIO.


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## skc (1 December 2008)

*Re: New pair trade - Long RIO / Short BHP*



Pairs Trader said:


> no correlation is measuring the strength of the relationship between two stocks, for example the current correlation reading on BHP/RIO is 96.90% which means they are almost in lockstep with each other. the rolling mean is the numerical representation of the day to day relationship between BHP & RIO.




Just wondering, how far in time do you go back to determine the mean and standard deviation? The takeover has been on the board for some 18 months so would you have to go back further than that? If so, do you / how dow you make adjustments to various company-transforming events like the Alcan takeover?

Thanks for sharing.


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## skyQuake (1 December 2008)

Correlation R^2
From 2003 - Now: 94.6%
03-07 : 95.1%
08-now : 88.4%


Jun07-Now : 64.2%


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## Sunder (1 December 2008)

Rio down 8.4% today, BHP down 3.5%

Not the greatest first day move. Will be watching this one to see how it pans out. 

Have you got a risk management/exit strategy?


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## Pairs Trader (2 December 2008)

added to the trade, long RIO @ 38.64 - short BHP @ 27.54

will add again if i get the opportunity

basic risk management is never commit more than 10% of your a/c to one stock, exit signal is generated when the pair comes back to its mean

the key to successful trading is making heaps of small trades that you have an edge with

I could lose on this trade and thats fine, however I know that over 50 or more trades my probability of outperforming the market is over 99%


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## prawn_86 (2 December 2008)

Pairs Trader said:


> risk management is *never commit more than 10% of your a/c to one stock*
> 
> I could lose on this trade and thats fine, however I know that over 50 or more trades my probability of outperforming the market is over 99%




Doesnt the amount committed depend on the risk, not the actual amount?

And 50 trades is not that big of a sampe size, but it depends on your timeframe i guess.


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## Frank D (2 December 2008)

Pairs,

Just in case you might want to know that RIO could easily follow a double monthly low pattern down into December lows.

I'd be extremely careful on adding positions.

I wouldn't touch RIO until it hits into the $18.00's


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## mazzatelli1000 (2 December 2008)

Pairs Trader said:


> the key to successful trading is making heaps of small trades that you have an edge with




Depends on what your strategy is --- again positive expectancy
Not criticising --- it may work for you------- but just in case someone very new to trading comes in and reads that thinking its the gospel..........


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## Pairs Trader (2 December 2008)

prawn_86 said:


> Doesnt the amount committed depend on the risk, not the actual amount?
> 
> And 50 trades is not that big of a sampe size, but it depends on your timeframe i guess.





Yes you adjust your size according to volatility in the pair, however as a line in the sand I never commit more than 10% to a stock, it works for me.


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## Pairs Trader (2 December 2008)

Frank D said:


> Pairs,
> 
> Just in case you might want to know that RIO could easily follow a double monthly low pattern down into December lows.
> 
> ...





This is what makes a trade, I buy you sell, will be interesting to watch it play out, I don't usually make trades with stocks recently affected by news, I like to look for trades when two similar correlated stocks diverge on no news at all, a true in-efficiency, however I on this one I feel the reaction has been justified but overdone, I expect it to snap back over the next several days-2 weeks, but hey ive been wrong before.


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## Pairs Trader (2 December 2008)

mazzatelli1000 said:


> Depends on what your strategy is --- again positive expectancy
> Not criticising --- it may work for you------- but just in case someone very new to trading comes in and reads that thinking its the gospel..........





Yes true, you can say this isn't the case for investors/traders like warren buffet as he makes a few, concentrated & large bets where each investment has high importance & correlation to overall performance, im referring to the other end of the spectrum(short term trading) where its generally the case the next trade outcome is random and over a large sample(over 100) the probability of generating a return becomes more predicatable.


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## rub92me (3 December 2008)

Pairs Trader said:


> added to the trade, long RIO @ 38.64 - short BHP @ 27.54
> 
> will add again if i get the opportunity
> 
> ...



Basic risk management should also tell you the following:
1) Not to add to your position if it isn't moving in the direction that you expected.
2) To have an exit / stop loss at which point you accept that you're wrong, rather than just have an exit criteria if you happen to be right.


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## prawn_86 (3 December 2008)

Pairs Trader said:


> I could lose on this trade and thats fine, however I know that over 50 or more trades my *probability of outperforming the market *is over 99%




This trade is still going backwards today. Where are your stops placed Pairstrader?

Also, to outperform the market you can still have a loss. IE - if you lost 25% but the market lost 30% you have outperformed but still lost 25%...


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## Pairs Trader (3 December 2008)

Added more this morning, Long RIO @ 36.22 - Short BHP @ 28.34

I don't add anymore than 3 layers to a pair trade.


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## Nyden (3 December 2008)

Probably a better trade just to short both


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## prawn_86 (3 December 2008)

I thought you were supposed to pyramid into winning trades, not losing ones 

Where are your stops PT?


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## Pairs Trader (3 December 2008)

I don't use stops, Ive found in almost every trading system that stops harm performance, not to mention slippage and exiting at the best opportunity. For example if a stock is trading at $10 per share and you think its worth $15 per share why would you exit if it goes down to $8 per share, you now have $2 less risk and $2 more reward, well thats how I view pair trading, the more it goes against you the less risk you have and more reward you get(based on the premise nothing has changed to the orginal reason why you entered the trade) and most trades do go against you initially thus giving you the opportunity to lower your cost average as you will never constantly nail the exact top or bottom, of course you can be wrong however if your risk management is prudent you won't ever blow yourself out of the water, with pair trading I don't use stops the program will generate an exit signal once the pair has returned to its rolling mean even at a loss or profit. With RIO/BHP, this pair is extremely volatility and thus risky, I can't believe how far it has diverged, if it does snap back it will happen with ferocious velocity.


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## prawn_86 (3 December 2008)

So you use technical indactors to determine fundamental 'value' and then dont use stops due to your fundamental leaning.

Sounds dangerous/risky/illogical to me.

Good luck


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## MS+Tradesim (3 December 2008)

Pairs Trader said:


> I don't use stops,.




Hello,

Tells me everything I need to know. 

Have a look at maximum adverse excursion. Good trades rarely go far against you.

Thank you.

MSbot.


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## skc (3 December 2008)

prawn_86 said:


> So you use technical indactors to determine fundamental 'value' and then dont use stops due to your fundamental leaning.
> 
> Sounds dangerous/risky/illogical to me.
> 
> Good luck




PT mentioned the 10% rule which is his risk management strategy... there is no stop price level per se on individual shares because the trade is a pair.

PT, I would really like to know in your trade screening, how do you adjust for any fundamental events that can lead one to believe that, two shares which used to behave a certain way would no longer do so.

For instance, whilst I think RIO / BHP should lock step (i.e. high correlation) due to underlying commidity price movements, but why should their share price relationship go back to historical mean, given the market is clearly putting a different risk profile to RIO due to it's debt.


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## Pairs Trader (3 December 2008)

prawn_86 said:


> So you use technical indactors to determine fundamental 'value' and then dont use stops due to your fundamental leaning.
> 
> Sounds dangerous/risky/illogical to me.
> 
> Good luck




I never said anything about using technical indicators to determine fundamental value.


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## Pairs Trader (3 December 2008)

MS+Tradesim said:


> Hello,
> 
> Tells me everything I need to know.
> 
> ...




May be the case for some systems, however this is the number 1 curve fitting tool(MAE) but if it works for you then thats all that matters. Most professional traders I know don't use stops, thats just my experience if yours differs then thats fine.


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## prawn_86 (3 December 2008)

Pairs Trader said:


> I never said anything about using technical indicators to determine fundamental value.




A curve fitting tool sounds like a technical indicator to me. Didnt you also state something about correlation, which is also TA if you ask me



Pairs Trader said:


> May be the case for some systems, however this is the number 1 curve fitting tool(MAE) but if it works for you then thats all that matters. Most *professional traders I know don't use stops*, thats just my experience if yours differs then thats fine.




Most professional traders i know do use stops. Name me one full time trader (not investor) that doesnt use stops.


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## Pairs Trader (3 December 2008)

skc said:


> PT mentioned the 10% rule which is his risk management strategy... there is no stop price level per se on individual shares because the trade is a pair.
> 
> PT, I would really like to know in your trade screening, how do you adjust for any fundamental events that can lead one to believe that, two shares which used to behave a certain way would no longer do so.
> 
> For instance, whilst I think RIO / BHP should lock step (i.e. high correlation) due to underlying commidity price movements, but why should their share price relationship go back to historical mean, given the market is clearly putting a different risk profile to RIO due to it's debt.





Changes in fundamental differences usually show up in a declining or increasing correlation chart, it all depends how long your average trade lasts for, the longer the trade the more attention you need to pay attention to fundamentals, the shorter the avg trade the more attention you pay to the technicals but in both cases you want to look at sentiment and enter at extremes. Again its up to the trader to take a educated guess based on experience whether the market has discounted, not discounted or over-discounted a fundamental event.

BHP/RIO does have high correlation but like you say recent events have lead to a re-pricing of the relationship, thus BHP has become stronger relative to RIO or RIO has become weaker relative to BHP and rightly so since the failed takeover, my belief is that this has not only been priced in but over-done since on a valuation basis RIO is some 40% cheaper relative to BHP, I would think a more rationale relative valuation for RIO would be around 25% cheaper than BHP to account for the debt situation. Plus in the last month RIO share price has gone from $82 to $37 and BHP has share price has been relatively unchanged so sentiment and technical oversold indicators are at extreme's for RIO and I'm speculating that the merger arb trades that were previously placed were huge and have been unwound dramatically thus causing a mis-pricing between the two stocks. I may be wrong I may be right, thats trading.


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## prawn_86 (3 December 2008)

So without stops at what stage do you concede you are wrong and exit?


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## Pairs Trader (3 December 2008)

Like ive said repeatedly, the program will generate an exit signal once the pair returns to its rolling mean, it could be a loss or a win. When I refer to pro traders not using stops, I'm talking about guys who trade prop/funds/groups for years that ive come in contact with not your famous market wizard trader, etc....no point in me mentioning names as you won't recognise them.

Most inside the industry know all about stops, how market makers take advantage of them, how there gunned for, etc...lots of dirty games being played here I can assure you.


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## wayneL (3 December 2008)

Nyden said:


> Probably a better trade just to short both




:iagree:

:band


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## skc (3 December 2008)

Pairs Trader said:


> Changes in fundamental differences usually show up in a declining or increasing correlation chart, it all depends how long your average trade lasts for, the longer the trade the more attention you need to pay attention to fundamentals, the shorter the avg trade the more attention you pay to the technicals but in both cases you want to look at sentiment and enter at extremes. Again its up to the trader to take a educated guess based on experience whether the market has discounted, not discounted or over-discounted a fundamental event.
> 
> BHP/RIO does have high correlation but like you say recent events have lead to a re-pricing of the relationship, thus BHP has become stronger relative to RIO or RIO has become weaker relative to BHP and rightly so since the failed takeover, my belief is that this has not only been priced in but over-done since on a valuation basis RIO is some 40% cheaper relative to BHP, I would think a more rationale relative valuation for RIO would be around 25% cheaper than BHP to account for the debt situation. Plus in the last month RIO share price has gone from $82 to $37 and BHP has share price has been relatively unchanged so sentiment and technical oversold indicators are at extreme's for RIO and I'm speculating that the merger arb trades that were previously placed were huge and have been unwound dramatically thus causing a mis-pricing between the two stocks. I may be wrong I may be right, thats trading.




Thanks for replying... I agree with you that it seems overdone. It also sounds like this is a trade where things may not revert back to the previous mean, but you can profit as along as it gets less extreme.


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## Trembling Hand (4 December 2008)

Pairs Trader said:


> When I refer to pro traders not using stops, I'm talking about guys who trade prop/funds/groups for years that ive come in contact with not your famous market wizard trader, etc




Yeah right!!

The whole back office/risk manager/ daily/ weekly/ monthly drop dead levels aren't stops.

Just LOL!!!


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## Frank D (4 December 2008)

Strict stops should be used on any form of leverage.

In saying that, I trade without stops using my own cash on stocks, I 
also employ a partial entry and exit strategy when trading using 
higher timeframe dynamics.


Just because you trade without stops doesn't mean you won't take a 
loss, but you also have to know when to exit the trade on any
 rotation upwards, and when to re-enter when there is a shift in 
support and/or resistance.

As pointed out recently, I wouldn't go near RIO until it was closer to 
$18 than $28.

Even though $28 could support price and get a short-term bounce.

And then the trader needs to know when to exit on any short-term bounce.

It seems to me that 'pairs' might use a probability strategy when markets
 are trendless, and can often be very profitable, but he should employ market
 'dynamic techniques' so that entries are much more robust.

The whole concept of market dynamics is understanding the shifts in 
support and resistance, which allows the trader to 'time' the entries 
better and hopefully make greater gains when prices do rotate back 
towards central zones.

just an opinion.


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## nomore4s (4 December 2008)

wow this trade has really gone pair shaped.

Sorry couldn't help it


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## Caliente (4 December 2008)

quite possibly one of the worst trades i've ever seen. Pyramiding three times into a losing position...

Hope he has a stop somewhere?


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## shaunQ (4 December 2008)

From a news report today.



> Miner BHP Billiton bucked the trend, gaining 1.4 per cent to $28.20, while Rio Tinto shares fell 10.24 per cent to $33.03.




Which is the opposite of the trade... ouch. maybe its 4 times lucky??

Anyway, good on you Pairs for putting your trade out there for discussion - I think 90% of users could have their trades picked apart by others with an opposing view.... as you said, there is always another person on the other end...

Unfortunetly looks like the wrong end this time...


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## skc (4 December 2008)

shaunQ said:


> Anyway, good on you Pairs for putting your trade out there for discussion - I think 90% of users could have their trades picked apart by others with an opposing view.... as you said, there is always another person on the other end...Unfortunetly looks like the wrong end this time...




Totally agree. 

Pairs Trader, you look like a seasoned trader (you even have your own logo!) so I hope you continue to update this thread with your thinking and trade management. 

I also hope that other posters stick to objective discussions (and lighthearted / non-offensive humor) so as not to discourage further posts/threads of a similar nature. We can all learn much one way or another.


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## Caliente (4 December 2008)

sorry! not really very constructive input from my end into the discussion. FWIW - I believe RIO has no way at the moment except for down.

*Current trend *= SP Down

*Rights Issue* = SP Down (dilution)

*Asset Sale* = stop the bleeding, but once again SP down as losses are realised.

Some announcement needs to be made to the market re: debt restructure or reduction to buck the trend.


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## Trembling Hand (4 December 2008)

shaunQ said:


> Anyway, good on you Pairs for putting your trade out there for discussion - I think 90% of users could have their trades picked apart by others with an opposing view.




Its not the result that matters its the process. How many would be happy with a leveraged trade (any trade) without stops?? How many think Averaging down is a winning strategy in this environment?? 

To me thats a crappy process no matter what the outcome. In fact what does one trade prove. Its a flip of the coin. As trade examples go you can prove three things,

1. You a smartar$e for posting the right one.
2. You are a dumbar$e for posting the wrong one.
3. You have a sound process for trade management no matter the outcome.

3 is the only one that counts. IMHO


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## nomore4s (4 December 2008)

shaunQ said:


> From a news report today.
> 
> 
> 
> ...




It's not so much the trade that people are picking apart - we all have bad trades. It's the management of the trade which is the problem imho, and this is the issue some of the other posters have raised. 
To me it appears like Pairs has kept averaging down in the hope of being right and has failed to recognise that the trade is going against him/her and take appropriate action and defend the position. But in saying that Pairs also appears to have a plan and this trade may be well within his/her risk profile and we also don't know how much was risked. But to me it was a very badly managed trade.

Managing the bad trades is half the battle in this game imo.

I also hope Pairs posts some more trades up as pairs trading isn't an overly common style on this forum and it could prove interesting and educational.


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## Pairs Trader (4 December 2008)

Thanks for everyone's positive comments, im not rattled by this trade at all, just another day for me, ive had plenty more trades go way further against me initially, this is the first trade ive posted on these forums and of course(murphys law) at the moment it doesn't look like a nice trade, however I can assure you all the payoff is much greater than the risk, im so tempted to add more to this pair however that would break my trading plan of averaging down more than 2 times, I can't believe the divergence between these two stocks, the widest in their respective trading histories, the market is pricing RIO irrationally at the moment. The market is overracting to the risk tied to Rio's net debt of roughly $42-billion, most of which is a holdover from last year's acquisition of Alcan Inc. (AL). The interest burden is well below 3%, meaning an annual interest charge of around $1.26-billion. That does not seem too punitive for a company with an estimated $23.8-billion of EBITDA this year and $19.8-billion next year & a strong balance sheet, plus who is to say that BHP won't revive a takeover bid for RIO at much more attractive prices, I will be riding out this trade till it reverts back to the mean(profit or loss I don't care) sorry to all those who believe in stops, maybe in other systems stops increase performance however in pair trading(arbitrage) it goes against the very reason for putting the trade on in the first place. 

If members were interested id be happy to start a pair trading journal to show everyone that pair trading without stops does work, yes maybe my next trade will be a loss, who cares thats trading, people that make attacks for one losing trade don't have the slighest idea about what successful trading really is, I know over a large amount of trades I will be making $$$ and outperforming the market with lower volatility and exposure. Trading is a mental battle.


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## Trembling Hand (4 December 2008)

Pairs what happens to your account in the following Arbitrage example.

GM Long, Ford short.

GM goes bankrupt Ford takes off because GM has had it??


That's right no such thing as a Black Swan in Arbitrage....... Now when did I last hear that???


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## mattlaw (4 December 2008)

Hi Pairs i am always interested in having a look at others trading styles/systems.

Matt


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## Pairs Trader (4 December 2008)

Trembling Hand said:


> Pairs what happens to your account in the following Arbitrage example.
> 
> GM Long, Ford short.
> 
> ...




I trade US pairs aswell at night and I can tell you there's certain stocks/industries you stay away from, the stocks & pairs you trade has a massive impact on your performance, for eg US financials/auto's have been off my watchlists all year and I probably won't trade them again in 09 aswell because of increased tail risk, that is the probability of a black swan event occuring, it doesn't take a genius to realise that financials and autos are at great risk of bankruptcy thus rendering pair trading dangerous in those industries. I don't think RIO is going bankrupt anytime soon as much as the market has been pricing in lately. I mostly stick to old-economy stocks for pair trading such as basic materials, energy, consumer, telecom, healthcare however most of my trades are in the US gold sector where there's hundred's of liquid pairs that all key off one constant thing, spot gold.


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## mazzatelli1000 (4 December 2008)

Uncanny how when one puts on a live demo of a trade it always seems to go wrong 

hahahaha

The Market Gods must have a sense of grotesque humour


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## cuttlefish (4 December 2008)

Its an interesting approach Pairs Trader, thanks for posting up an example. 

It could be a useful strategy in an uncertain market in that its effectively a spread trade and sort of delta neutral at a sector level I suppose.  I guess that also effectively builds some inherent protection into the trade.

What instrument are you using to set up the short/long positions - are they direct equities or via some other instrument?

Also what is the longest time you would hold without the gap between the pair reverting to the mean?  And what is a typical timeframe for a trade?

Is it just divergence exceeding a certain level that triggers your entry?  I was wondering if it might be possible to optimise the entry by waiting for a reversal in the divergence before entering  (possibly chart the divergence and look for a technical indicator of a reversal?).


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## mazzatelli1000 (4 December 2008)

cuttlefish said:


> What instrument are you using to set up the short/long positions - are they direct equities or via some other instrument?




You can use verticals on ETF's
Limited risk, and if you can set it up for an initial credit - even if both don't move you can still make a little.

But I do not put these trades on very often - very much tinkering 
So do your own research


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## Pairs Trader (4 December 2008)

mazzatelli1000 said:


> Uncanny how when one puts on a live demo of a trade it always seems to go wrong
> 
> hahahaha
> 
> The Market Gods must have a sense of grotesque humour




yes I know, however the outcome of the next trade really is random.

plus the trade isn't wrong yet, I haven't closed the trade, to give you all an idea of where the current mean is on BHP/RIO the spread(RIO-BHP) would have to be around $20, currently its at $5 and Im long at an avg of $9.81


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## nomore4s (4 December 2008)

Don't you think that in current market conditions with RIO's huge debt levels, the low commodity prices and uncertainity about where the money will come from to pay its debt down that the spread between BHP & RIO could widen even further and stay that way for a while?

I think the market is justified in punishing RIO atm and will continue to do so until some of its problems are sorted out. Compared to RIO BHP is looking very strong atm.
I suppose my point is that market conditions & fundamentals have changed so maybe the spread between these 2 has changed.

Interesting article on RIO here.


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## Pairs Trader (4 December 2008)

cuttlefish said:


> Its an interesting approach Pairs Trader, thanks for posting up an example.
> 
> It could be a useful strategy in an uncertain market in that its effectively a spread trade and sort of delta neutral at a sector level I suppose.  I guess that also effectively builds some inherent protection into the trade.
> 
> ...




Yes pair trading thrives in uncertain/sideways/volatile markets like this one and I continue to belive it will be this type of environment for quite some time. I trade CFD's & equities for pair trading, depending what exchange the pair is on. The average trade lasts about 5-8days and I always hold until the pair reverts back to its mean. Yes my entry layers are based on set intervals of standard deviations away from the mean, then I use a intra-day spread chart to pinpoint my entries. Some traders wait for a reversal or tick-down before entering and thats fine, however I like to enter at the extremes and key in before the reversal where big $$$ can be made, lower strike rate but higher payoff.


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## Pairs Trader (4 December 2008)

nomore4s said:


> Don't you think that in current market conditions with RIO's huge debt levels, the low commodity prices and uncertainity about where the money will come from to pay its debt down that the spread between BHP & RIO could widen even further and stay that way for a while?
> 
> I think the market is justified in punishing RIO atm and will continue to do so until some of its problems are sorted out. Compared to RIO BHP is looking very strong atm.
> I suppose my point is that market conditions & fundamentals have changed so maybe the spread between these 2 has changed.
> ...




yes those are true factors and RIO should become cheaper relative to BHP, but not to the extent that has occured recently. generally what you read in the news has already been priced in. RIO is getting pounded much like how BNB, CNP, CIY, AFG, etc... started getting pounded before there demise, however don't be fooled by heavy hedge fund selling and circulating media articles titled ''RIO blew it'' which is nothing more the over-hyped propaganda creating artificial fear, RIO ain't going under, RIO still has a strong balance sheet, strong cash flows & a strong future. Extreme sentiment is the most effective contrarian indicator.


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## MRC & Co (4 December 2008)

nomore4s said:


> I also hope Pairs posts some more trades up as pairs trading isn't an overly common style on this forum and it could prove interesting and educational.




Absolutely.  Good stuff Pairs.

As long as you don't average down way offside, averaging down can make for some CRACKER trades when the elastic flings back the other way!  

I don't do it personally, but many many traders much better than I, do.

Sounds like Pairs has his own style, that works for him and is unique.  Exactly what is required and he probably did his time creating it!


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## TheAbyss (5 December 2008)

Interesting to say the least at the moment. I have attached a chart for RIO and BHP for the last decade and the similarities are very real.

I am aware that currently the two have differing market sentiment at the moment and the exposed facts are that Rio has gone out on a limb from a debt perspective and BHP is currently considered the safe haven.

The chart suggests the two are joined at the hip so should they both be shorted?


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## wayneL (5 December 2008)

mazzatelli1000 said:


> Uncanny how when one puts on a live demo of a trade it always seems to go wrong
> 
> hahahaha
> 
> The Market Gods must have a sense of grotesque humour




A long time ago, I posted the quote below on another forum, as comfort for someone who blew up a live posted trade.

Then, Mr Murphy smacked me on the back of the head on this forum, when Sails kindly reminded me of it.

Here, for the benefit of Mr Pairs



> Murphy's Law
> Section 34,
> Subsection 13,
> paragraph (c),(iii) states that:
> ...


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## awg (5 December 2008)

question from a baby at pair trading knowledge,

would it be correct to characterize Pair trading as predominately Technical trades?

it seems to me there has been a Fundamental shift, that is relative debt.

I do realise that Pair Trader took this trade after the announcement, and commendably and bravely posted it.

so obviously sentiment and perception are considered


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## aleckara (5 December 2008)

I saw this on the forum awhile back and thought that it wouldn't go well when he first posted it. Reason being is that Rio haven't been in this much debt for a long time vs BHP. The fundamentals have changed in the short term at least. The market hates debt at the moment and is afraid of causes of insolvency.

It always pays to look at both sides of the coin both FA and TA. Then again if he had just used other TA methods he wouldn't have gone against the trend when the stock looks inheritently risky right now

I'm a relatively newbie and don't have a lot of confidence so take what I say with a lot of salt.


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## Pairs Trader (5 December 2008)

aleckara said:


> I saw this on the forum awhile back and thought that it wouldn't go well when he first posted it. Reason being is that Rio haven't been in this much debt for a long time vs BHP. The fundamentals have changed in the short term at least. The market hates debt at the moment and is afraid of causes of insolvency.
> 
> It always pays to look at both sides of the coin both FA and TA. Then again if he had just used other TA methods he wouldn't have gone against the trend when the stock looks inheritently risky right now
> 
> I'm a relatively newbie and don't have a lot of confidence so take what I say with a lot of salt.




This is like saying ''do you know its friday today'' 
taken with a barrel of salt

everything in hindsight is perfectly clear, I don't trade looking in the rear view mirror I look straight ahead, take my chances, make a bet and stick it out, there's no such thing as a wrong decision because at the time it was the right decision, you can only learn from it and apply it in the future to ensure you make the ''right'' decision, Im still happy with the risk/reward profile of this trade and currently the spread is only down $3 from my avg, not that far under water, when we get a uptick in oil/equities RIO share price will respond favourably to that.


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## aleckara (5 December 2008)

Pairs Trader said:


> This is like saying ''do you know its friday today''
> taken with a barrel of salt
> 
> everything in hindsight is perfectly clear, I don't trade looking in the rear view mirror I look straight ahead, take my chances, make a bet and stick it out, there's no such thing as a wrong decision because at the time it was the right decision, you can only learn from it and apply it in the future to ensure you make the ''right'' decision, Im still happy with the risk/reward profile of this trade and currently the spread is only down $3 from my avg, not that far under water, when we get a uptick in oil/equities RIO share price will respond favourably to that.




I guess I worded it wrong. Because I'm relatively new at this I wasn't comfortable with posting at the time. It wasn't hindsight just my perception of risk of RIO relative to BHP for at least the days you were talking about. Now might be a good time to get into the trade you are trying to do but a few days ago thought that the trend had not stopped its falling. After all you seem a lot more experienced with trading than I am; I'm relatively a lot more risk averse. My opinion therefore is not as credible and that's why I didn't post, but the above was my opinion at the time.

I do hope the trade goes well for you. Pairs trading is an interesting form of trading from what I've read. The one factor is that the corellation needs to be intact for it to work. What we saw was a one off break in corelation between the two. Even if the correlation kicks back in it won't undo the profit you lost. It needs to break the other way.


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## peter2 (5 December 2008)

Pairs I would like to understand what it is that you are trading. 
Is it the absolute difference in the stock prices or a ratio? 

eg. RIO at $40, BHP at $30; RIO-BHP diff = $10, RIO/BHP ratio = 1.33
Now RIO at $30, BHP at $25; diff = $5, ratio = 1.20

Your numbers indicate the price difference but I am assuming you're trading the ratio.


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## peter2 (5 December 2008)

Another thought.
I understand that mean reversion systems work best when the mean does not move very much. Abnormal price swings will tend to revert to the mean. If the price swing is too big then it will move the mean in the direction of the swing. There is the distinct possibilty that the historical RIO/BHP relationship is changing and another significantly different valued ratio may be established. This trade will exit when enough time has elapsed for the ratio to catch the price spread. It could be that this trade will never be profitable and you may wait 6 mths or more to find this out.

I understand your decision to not use a technical stop loss, but I can't see the logic in letting a small $ loss become a bigger $ loss especially if there is evidence that the context (historical ratio) of the trade is invalidated. 

This trade could be exited if the historical relationship deviates significantly from its norm. The major problem using something like this is the fact that a ratio is a lagging indicator and by the time the ratio signals that the original trade context has changed, price may be miles away and your losses huge.


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## cuttlefish (5 December 2008)

Well the gaps headed back into the right direction for the trade after todays close.   RIO only down 50c (1.54%),  BHP down a hefty 1.35 (4.91%).


I was curious about whether the trade is ratio'd or just the absolute gap as well Peter - it will be interesting to hear Pair's answer.


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## derty (11 December 2008)

This thread has been a bit quiet - how it the trade going Pairs? RIO back up to $40. You still in the trade?


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## Pairs Trader (11 December 2008)

derty said:


> This thread has been a bit quiet - how it the trade going Pairs? RIO back up to $40. You still in the trade?





Yes trade is still open and just became profitable today. still has a bit more to go before I exit.


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## cuttlefish (11 December 2008)

Well done pairs trader - thanks for the example - let us know how it ends up when you close it.


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## MRC & Co (11 December 2008)

Pairs Trader said:


> Yes trade is still open and just became profitable today. still has a bit more to go before I exit.




Excellent hold.

Good to hear.


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## michael_selway (11 December 2008)

Pairs Trader said:


> Yes trade is still open and just became profitable today. still has a bit more to go before I exit.




Hey nice work that you are holding

I think the best point was Long RIO at $30 and short BHP at $30.00 a few days ago

Also how high do you think RIO will go (and how long BHP can go) from here onwards?



Pairs Trader said:


> Hi all, thought I would take a chance and make a trade in front of everyone, im long RIO this morning from 43.69 and short BHP from 29.72 as I think it has over reacted from the aborted takeover news as this pair is over 3 standard deviations from its mean. Will scale into more if I can lower my cost average, looking to exit over the next several days, will advise when.




Thx

MS


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## rub92me (11 December 2008)

Pairs Trader said:


> Yes trade is still open and just became profitable today. still has a bit more to go before I exit.



It can only be in profit now if you increased the size of trades in the second and especially third time. If not based on the figures you gave us you're still down (provided you put the same amount of dollars long RIO and short BHP at each pairs trade).


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## MRC & Co (11 December 2008)

Averaged down exponentially (right use of words?) to decrease average price far quicker.

High risk, but it does work for some guys with conviction.


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## Pairs Trader (12 December 2008)

Yes increased size on the 2nd and 3rd layers, I know this scares some people, however I have a trading plan with strict risk controls. You can view each layer as its own system. As 2nd & 3rd layer opportunities occur less often than 1st layer trades, overall I actually commit more $$$ to my 1st layer trades, its all in the way you view it. Like ive said before you will never pick the exact bottom or top all you can do is take advantage of volatility to lower your cost average. Try and think of stocks like say a carton of beer. For example my favourite beer, hoegaarden, which normally is about $70 per carton, if I saw it on special for one day only at $60 I would buy 2 cartons, If I saw it on special for one day only for $50 I would buy 3 cartons, some traders would buy a carton for $70 and if they saw it go down to $50 they would go and sell it back to the bottle shop  This is a game where those with the highest conviction & the lowest cost average wins.


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## skc (12 December 2008)

Pairs Trader said:


> Yes increased size on the 2nd and 3rd layers, I know this scares some people, however I have a trading plan with strict risk controls. You can view each layer as its own system. As 2nd & 3rd layer opportunities occur less often than 1st layer trades, overall I actually commit more $$$ to my 1st layer trades, its all in the way you view it. Like ive said before you will never pick the exact bottom or top all you can do is take advantage of volatility to lower your cost average. Try and think of stocks like say a carton of beer. For example my favourite beer, hoegaarden, which normally is about $70 per carton, if I saw it on special for one day only at $60 I would buy 2 cartons, If I saw it on special for one day only for $50 I would buy 3 cartons, some traders would buy a carton for $70 and if they saw it go down to $50 they would go and sell it back to the bottle shop  This is a game where those with the highest conviction & the lowest cost average wins.




Good stuff on the trade, PT. 

Not so sure about the analogy of beer purchasing... it is more like buying cartons of pears imo. You have to look inside the carton to double check when they are on sale, but then it's OK to buy more at the lower price once you found that the product quality is still good. 

You know those fruit markets are controlled by the underground world and all that... so one must be careful, just like the share market.


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## rub92me (12 December 2008)

Pairs Trader said:


> Yes increased size on the 2nd and 3rd layers, I know this scares some people, however I have a trading plan with strict risk controls. You can view each layer as its own system. As 2nd & 3rd layer opportunities occur less often than 1st layer trades, overall I actually commit more $$$ to my 1st layer trades, its all in the way you view it. Like ive said before you will never pick the exact bottom or top all you can do is take advantage of volatility to lower your cost average. Try and think of stocks like say a carton of beer. For example my favourite beer, hoegaarden, which normally is about $70 per carton, if I saw it on special for one day only at $60 I would buy 2 cartons, If I saw it on special for one day only for $50 I would buy 3 cartons, some traders would buy a carton for $70 and if they saw it go down to $50 they would go and sell it back to the bottle shop  This is a game where those with the highest conviction & the lowest cost average wins.



If it works for you, all the best. Lowering your cost average is increasing your risk. As for the beer comparison. It could be that the $50 cartons you bought were priced that low because they came off a bad bottling batch and taste like cat's urine. Sure, you got a bargain, but you won't enjoy it much.


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## BradK (12 December 2008)

Interesting to see the tone of thread change once the trade became profitable. Shaudenfreude is alive and well at ASF... 

Brad


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## prawn_86 (12 December 2008)

BradK said:


> Interesting to see the tone of thread change once the trade became profitable. Shaudenfreude is alive and well at ASF...
> 
> Brad




Personally i still think its highly risky and unconventional to 'average down' on a technical analysis based trade.

But as we all know sometimes its the unconventional things that make the cash, and i have no idea about how pair trading actually works, so well done to PT.

Let us know the next trade you take i'd be interested to see it too


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## cuttlefish (12 December 2008)

Its still important to remember that overall this pairs trade is a bit like an options spread in that its includes a short and long bet in two blue chips in the same market sector.  That means it has a level of in-built protection against strong market or sector moves in one direction or the other.  

The averaging down is averaging down into a spread (i.e. its really a combination of averaging down and pyramiding up).


One significant difference between the two companies at the moment is their debt profile and this is something I would argue should have been factored into the decision to take the trade because the market is certainly punishing leverage at the moment.  I'm assuming that in the ideal pairs trade the stocks are as similar as possible.

I guess NCM/LGL would be an interesting candidates to look at for pairs opportunities as well.


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## rub92me (12 December 2008)

BradK said:


> Interesting to see the tone of thread change once the trade became profitable. Shaudenfreude is alive and well at ASF...
> 
> Brad



My tone hasn't changed. A profitable trade is not the same as a good trade. A pairs trade in the opposition direction taken at the same time with tight trailing stops would have allowed better risk management and (depending on position sizing) an equal or better result.


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## BradK (12 December 2008)

rub92me said:


> My tone hasn't changed. A profitable trade is not the same as a good trade. A pairs trade in the opposition direction taken at the same time with tight trailing stops would have allowed better risk management and (depending on position sizing) an equal or better result.




Im certainly not having a go at anyone - I am just making an observation. Sorry for any offence taken. 

Brad


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## Pairs Trader (12 December 2008)

rub92me said:


> My tone hasn't changed. A profitable trade is not the same as a good trade. A pairs trade in the opposition direction taken at the same time with tight trailing stops would have allowed better risk management and (depending on position sizing) an equal or better result.




yes everything in hindsight is perfectly clear.


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## rub92me (12 December 2008)

Pairs Trader said:


> yes everything in hindsight is perfectly clear.



Sorry mate, but hindsight has nothing to do with my observations. I'm not trying to prove that I could have done a more profitable trade. Just giving my view on the risk management of the trade. And it has been the same throughout from the point you added to the trade, to were it moved against you, then in your favour and then against you again. Never mind, we obviously have a different view of and approach to risk and that is fine with me.


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## skc (12 December 2008)

Pairs Trader said:


> yes everything in hindsight is perfectly clear.




Today it's gone backwards again. Terrible, terrible... :headshake

<Please read the following when the trade goes back into profit>

Well done, PT. Great hold.


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## beerwm (12 December 2008)

Hi Pair Trader

Thanks for posting this trade.

I;m just a newbie, but i was wondering what degree of divergence you use to trigger an entry point into a trade like this?

and have u tried using stops in the past to protect against a continuing divergence? what results did u find

thanks, and good luck


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## MRC & Co (12 December 2008)

Yeh, at what point, if the divergence continues, do you cut losses and just exit the trade?


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## BentRod (12 December 2008)

Just having a quick look at the charts for this trade but not sure I have done it right in Amibroker??

This is from about the last 6 months with the red line being Dec 1 when pairs took the trade.

Pairs...can you post the chart that you use?


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## peter2 (12 December 2008)

There is further info on the website at the bottom of Pairs Trader's posts for those interested.


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## skc (13 December 2008)

BentRod said:


> Just having a quick look at the charts for this trade but not sure I have done it right in Amibroker??
> 
> This is from about the last 6 months with the red line being Dec 1 when pairs took the trade.
> 
> Pairs...can you post the chart that you use?




Personally would have charted $RIO/$BHP...


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## Pairs Trader (5 January 2009)

Exited this trade for a small profit;

Sold RIO @ 42.05
Covered BHP @ 31.43
Spread = 10.62

Spread still has a good chance of getting wider over the next week or so, however I see capital better deployed elsewhere.


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## cuttlefish (5 January 2009)

Pairs Trader said:
			
		

> im long RIO this morning from 43.69 and short BHP from 29.72





Pairs Trader - congrats on the small profit - although I'm assuming it hasn't been your most succesful pairs trade it is a vindication at least that it did eventually return to profit. What it did do is demonstrate some of the safety mechanisms built into the pairs concept - so thanks for the example.

I also note that had you not 'averaged down' into the trade then at the moment it would still be showing a loss - so clearly in this instance at least the idea of adding to the trade as it went against you worked.


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## hardcoremike (27 February 2009)

I enjoyed reading your trade. please update us when you have more pair trades.
Cheers


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## nizar (27 February 2009)

Interesting pair this one.
Over the last 4 months very poorly correlated yet strongly correlated when you look at 18 months+

How fair back do you look to measure the degree of correlation?


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## Pairs Trader (27 February 2009)

Thanks guys, please ask any new questions in the pair trade journal https://www.aussiestockforums.com/forums/showthread.php?t=14508 just to keep things tidy.


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## Barndat (10 August 2009)

Hey has anyone that has purchased Pairtraders Software or even just using it on the 30 day trial made any trades worth posting here? 

There doesn't seem to be many trades coming up recently or maybe there is just a lack of interest in the system. 

I thought we should use this thread to avoid cluttering up PairTraders Stock Trade journal.  

Thanks for any replies....


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## samgribbles (10 August 2009)

yes. a few.  its not as automated as it might first appear.  you still need to put a lot of time into checking for missing data, market caps, news events, fundamental valuations, stock charts.  Crashes regularly but restarts OK.

No such thing as free and easy money though!

Having said that.  It shouldnt take you too many trades using only a few thousand in a CFD a/c to make up the purchase cost


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## auric (11 August 2009)

agree with sam , crashes a bit also check data as uses yahoo, also for the asx i use 

http://tradingroom.com.au/apps/mkt/industrylisting.ac

to check market cap etc

would be good to be able to use own database 
i have brought the software as it is a great time saver at present only pairs thrown up for me yesterday to watch
are  
mcw/mof
sdg/mof
ori/abc
wsa/omh
wsa/mcr
they still need checking though !


cheers


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## Barndat (11 August 2009)

samgribbles said:


> yes. a few.  its not as automated as it might first appear.  you still need to put a lot of time into checking for missing data, market caps, news events, fundamental valuations, stock charts.  Crashes regularly but restarts OK.




When checking for missing data, do you compare to EOD data from another source? Can u replace data in one individual stock from the other source i.e. Commsec EOD. 

With the prg crashing, is this the PTF prg itself or does the computer lock up completely?

I have backtested results from the PT journal and found that you could trade with similar success using EOD data. Since I have had enough screen time to last me a lifetime this would suit me. What do you think?

Thanks..


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## auric (11 August 2009)

does not lock the computer up just the program usually happens if it is updating the data and you do a backtest or something 
i would like to use my own data as well hope they do an upgrade for this


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## charley (30 August 2009)

I purchased the software 2 months ago and have been using it daily and finding it very interesting. So far, I have only been paper trading as I have 2 Scottrade accounts; one only has very limited funds and just recently has had shorting capability and the much larger one is an IRA and IRS will not allow shorting with it like I had been planning! I will be adding funds to the lesser account next week and going live. My paper results have been more than I expected, and yes, I know real trading is much more risky. But given my learning curve in the past successes, I'm sure I can make money in the future with the gained knowledge! I consistently make $75 to $300 profit in between 4 days and 4 weeks using $3000/$3000 long and short pairs. Now, I am being much more selective in my pairs and found some that produce very poor results and avoid those types and others that I will pursue.

Given more interest in this forum and other contributors, I will post trades a day late and compare notes as to potential, %, spread, volitility, etc. There's lots to learn and I would like to hear from those that have been in it for a while longer than me!


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## Freddy (23 December 2009)

If you go back through the old thread, you will find my summary that I use to trade.  Up 66% in 4 months on $5000 capital and trading 1000 shares each time on each leg.


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## Wysiwyg (23 December 2009)

On the surface this idea is silly. The price action from December still shows correlation and the divergence of price. BHP has gained 40% and RIO has gained 115%. Pair trading correlated stocks is strange.


> With the help of others at Morgan Stanley at the time, including Nunzio Tartaglia, Bamberger found that certain securities, often competitors in the same sector, were correlated in their day-to-day price movements.
> 
> *When the correlation broke down*, i.e. one stock traded up while the other traded down, *they would sell the outperforming stock and buy the* *underperforming one*, *betting that the "spread" between the two would** eventually converge.*




This is pair trading?


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## cooper1308 (9 January 2010)

This is why I find pure technicals difficult to interpret. If you change a few data points, the trade looks like a completely different setup (in my example perfect)... Not just in Pair Trading, but in general...


BHP/RIO 3 month







5 Year







I guess the use of statistics (i.e z-score) helps remove the bias that can be associated with relying  purely on charts.


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## Sugar Dunkaton (22 May 2011)

has the big pair trade journel thread been taken down?


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## vbahuja (31 January 2021)

Pairs Trader said:


> *Re: New pair trade - Long RIO / Short BHP*
> 
> no correlation is measuring the strength of the relationship between two stocks, for example the current correlation reading on BHP/RIO is 96.90% which means they are almost in lockstep with each other. the rolling mean is the numerical representation of the day to day relationship between BHP & RIO.



how do you find the correlation. is their any site for it?


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