New pair trade - Long RIO/Short BHP

[Pairs Trader]

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.

 

[julius]

Re: New pair trade - Long RIO / Short BHP

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

Which mean are you talking about ?

 

[Pairs Trader]

Re: New pair trade - Long RIO / Short BHP

the rolling relationship average

 

[julius]

Re: New pair trade - Long RIO / Short BHP

Is this similar to correlation ?

 

[Pairs Trader]

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.

 

[skc]

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.

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.

 

[skyQuake]

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


Jun07-Now : 64.2%

 

[Sunder]

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?

 

[Pairs Trader]

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%

 

[prawn_86]

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.

 

[Frank D]

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

 

[mazzatelli1000]

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..........

 

[Pairs Trader]

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.

 

[Pairs Trader]

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

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.

 

[Pairs Trader]

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.

 

[rub92me]

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%

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.

 

[prawn_86]

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%...

 

[Pairs Trader]

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

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

 

[Nyden]

Probably a better trade just to short both

 

[prawn_86]

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

Where are your stops PT?