# Pairs trading



## It's Snake Pliskin (26 January 2009)

Who pair trades and does it work?

Is pair trading a strategy worth employing for small traders and in small markets?


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## ducati916 (27 January 2009)

It's Snake Pliskin said:


> Who pair trades and does it work?
> 
> Is pair trading a strategy worth employing for small traders and in small markets?





I've experimented in the past with it. Not that impressed. The main problem is when you are wrong. In most trades, direction is an important paremetre, and will indicate when you are wrong [in your timeframe]

Pairs relies on the spread, thus direction is removed. Therefore judging the spread becomes a statistical problem. Markets being fractal, kinda destroy the statistical analysis, leaving you a little bit in the dark. Not really where you want to reside.

Empirically I have found lot's of small wins, with large losses. Horrible way to trade really.

jog on
duc


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## wayneL (27 January 2009)

ducati916 said:


> I've experimented in the past with it. Not that impressed. The main problem is when you are wrong. In most trades, direction is an important paremetre, and will indicate when you are wrong [in your timeframe]
> 
> Pairs relies on the spread, thus direction is removed.* Therefore judging the spread becomes a statistical problem.* Markets being fractal, kinda destroy the statistical analysis, leaving you a little bit in the dark. Not really where you want to reside.
> 
> ...




If one was intent on pairs trades, futures spreads are probably the way to go as there are "real" statistical correlations that can be used, particularly when spreads are on the same commodity, but different contracts.

I haven't ventured there myself, but there are loads of books on the subject.


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## ducati916 (27 January 2009)

wayneL said:


> If one was intent on pairs trades, futures spreads are probably the way to go as there are "real" statistical correlations that can be used, particularly when spreads are on the same commodity, but different contracts.
> 
> I haven't ventured there myself, but there are loads of books on the subject.





True enough [regarding futures] I should have qualified my observations to pairs of common stocks.

XOM/CVX, FNM/FRE, WMT/TGT GLD/GDX, XOM/GLD are some examples that I have traded in the past. Airlines are pretty good pairs DAL/CAL 

jog on
duc


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## It's Snake Pliskin (28 January 2009)

ducati916 said:


> I've experimented in the past with it. Not that impressed. The main problem is when you are wrong. In most trades, direction is an important paremetre, and will indicate when you are wrong [in your timeframe]
> 
> Pairs relies on the spread, thus direction is removed. Therefore judging the spread becomes a statistical problem. Markets being fractal, kinda destroy the statistical analysis, leaving you a little bit in the dark. Not really where you want to reside.
> 
> ...



Thanks for your opinions Duc and Wayne.


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## Nick Radge (28 January 2009)

Snake,
Another way to look at pairs, rather than straight price correlation, is using a percentage change chart from a fixed start date and then identifying high correlations. 

As an example, compare ANZ and NAB below on a percentage change chart. The lower section shows that the spread between the two rotate back and forth around 0. Whenever it tags +10 you'd be a seller of ANZ and a buyer of NAB. When it tags -10 you do the reverse. You would always cover when the spread came back to zero.

Since 2006, a $50,000 investment into this strategy would have yielded a profit of $27,922. Six trades, six wins. 



However, and isn't there always a catch. Firstly in Australia its difficult to find truly high correlated stocks like this pair, so perhaps the US would be a better place to look (and for commission purposes as well). Second, the spreads are a moving price themselves so they can, and will, start to diverge eventually. If they diverge sharply then you'll take a heavy knock unless you know when enough is enough. It's the black swan events that wreak havoc, even with the pro's. Interest rate spreads in Australia and hugely traded by banks and large private traders, but in 2000 with the uncertainty around the clocks ticking over the spreads just kept widening and widening. The more they widen, you know the better the deal, but the pain must be stopped at some stage. 


_This post may contain advice that has been prepared by Reef Capital Coaching ABN 24 092 309 978 (“RCC”) and is general advice and does not take account of your objectives, financial situation or needs. Before acting on this general advice you should therefore consider the appropriateness of the advice having regard to your situation. We recommend you obtain financial, legal and taxation advice before making any financial investment decision._


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## ducati916 (28 January 2009)

*Nick*

There are many pairs actively traded. Can only load a maximum of 5, however there are probably 20+ that are actively traded in large size.


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## Nick Radge (29 January 2009)

Thanks Grant. As I said, the US is more than likely a better place, not only for opportunity as you rightly point out, but because commissions on the double-sided transaction will help out immensely.


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## It's Snake Pliskin (29 January 2009)

Thanks Nick for the chart and ideas. I thas given me something to think about and tinker with. 
Cheers..


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