New pair trade - Long RIO/Short BHP

[Pairs Trader]

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.

 

[prawn_86]

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

 

[MS+Tradesim]

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.

 

[skc]

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.

 

[Pairs Trader]

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.

 

[Pairs Trader]

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.

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.

 

[prawn_86]

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

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.

 

[Pairs Trader]

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.

 

[prawn_86]

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

 

[Pairs Trader]

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.

 

[wayneL]

Probably a better trade just to short both

:iagree:

:band

 

[skc]

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.

 

[Trembling Hand]

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!!!

 

[Frank D]

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.

 

[nomore4s]

wow this trade has really gone pair shaped.

Sorry couldn't help it

 

[Caliente]

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

Hope he has a stop somewhere?

 

[shaunQ]

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...

 

[skc]

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.

 

[Caliente]

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.

 

[Trembling Hand]

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