New pair trade - Long RIO/Short BHP

[nomore4s]

From a news report today.



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...

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.

 

[Pairs Trader]

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.

 

[Trembling Hand]

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???

 

[mattlaw]

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

Matt

 

[Pairs Trader]

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???

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.

 

[mazzatelli1000]

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

 

[cuttlefish]

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?).

 

[mazzatelli1000]

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

 

[Pairs Trader]

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

 

[nomore4s]

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.

 

[Pairs Trader]

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?).

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.

 

[Pairs Trader]

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.

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.

 

[MRC & Co]

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!

 

[TheAbyss]

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?

 

[wayneL]

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:

"All trades posted on a public forum, in particular, trades posted with the express purpose of education, and especially those trades in which the author is convinced of the high probability of a favourable outcome, shall fail miserably and spectacularly.

Not withstanding the above, the publically posted trade shall be the only losing trade on the traders books at the time and duration of the said trade. Ipso facto, all other non posted trades on the authors books shall be spectacularly successful so long as they shall remain unposted."

 

[awg]

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

 

[aleckara]

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.

 

[Pairs Trader]

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.

 

[aleckara]

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.

 

[peter2]

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.