Pairs Trading Strategy
Pairs trading strategy was introduced in 1980s, but over the past it was practiced exclusively by institutional trades and hedge funds. The strategy became popular among retail traders after the introduction of online trading of financial instruments. Pairs trading strategy is a market neutral strategy, enabling the trader to profit from both market ups and downs.
Pairs trading strategy works with stocks, options, futures and currencies. The trader first identifies a pair of instruments which show great correlation. In stocks trading, it is often two stocks of same industry (or two related industries); the trader, when he identifies a diversion from relative performance, takes long position for one stock (under performing stock) and shortens the other (the over performing stock). The cost for long position is partially or fully covered from revenue from short position. Pairs stock trader profit when stocks of the pair converge to original correlation.
In options trading, the pair can be options on two highly related stocks. The trader writes a call option for the outperforming stock and put option for underperforming stock. In futures trading, it is a pair of mini or full-size contract or futures on related instruments. The trader takes long position for one future and short for other.
In pairs trading strategy, the most difficult task and major success determining factor is finding instruments with high correlation. Trading pairs can be figured out using both fundamental and technical analysis tools. The position sizing and timing of trades are also very important. Often a pairs trading opportunity last for a short-time, thus the trader needs automated trading systems and faster decision making skills.
NobleTrading.com Offers Online Stock Trading, Online Options Trading
Online Futures Trading, Online Forex Trading
Worldwide Brokerage Service, Day Trading Brokerage
Pairs trading strategy works with stocks, options, futures and currencies. The trader first identifies a pair of instruments which show great correlation. In stocks trading, it is often two stocks of same industry (or two related industries); the trader, when he identifies a diversion from relative performance, takes long position for one stock (under performing stock) and shortens the other (the over performing stock). The cost for long position is partially or fully covered from revenue from short position. Pairs stock trader profit when stocks of the pair converge to original correlation.
In options trading, the pair can be options on two highly related stocks. The trader writes a call option for the outperforming stock and put option for underperforming stock. In futures trading, it is a pair of mini or full-size contract or futures on related instruments. The trader takes long position for one future and short for other.
In pairs trading strategy, the most difficult task and major success determining factor is finding instruments with high correlation. Trading pairs can be figured out using both fundamental and technical analysis tools. The position sizing and timing of trades are also very important. Often a pairs trading opportunity last for a short-time, thus the trader needs automated trading systems and faster decision making skills.
NobleTrading.com Offers Online Stock Trading, Online Options Trading
Online Futures Trading, Online Forex Trading
Worldwide Brokerage Service, Day Trading Brokerage
posted by NobleTrading at
8:24 AM
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