New pair trade - Long RIO/Short BHP

[peter2]

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.

 

[cuttlefish]

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.

 

[derty]

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

 

[Pairs Trader]

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.

 

[cuttlefish]

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

 

[MRC & Co]

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.

 

[michael_selway]

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?

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

 

[rub92me]

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).

 

[MRC & Co]

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

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

 

[Pairs Trader]

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.

 

[skc]

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.

 

[rub92me]

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.

 

[BradK]

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

Brad

 

[prawn_86]

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

 

[cuttlefish]

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.

 

[rub92me]

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.

 

[BradK]

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

 

[Pairs Trader]

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.

 

[rub92me]

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.

 

[skc]

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.