Pairs Trading UK & US Stocks Journal

As I promised 2 weeks ago in the thread ''Trading UK shares for a living'' im going to start a journal detailing my trades and show that it can be done. Ive been inspired by a similar trading journal on another forum with the trader doing very well and actually getting better results with the help of other members, so in the interest of creating something useful and informative im going to document my analysis and trades here, where I hope to improve aswell and maybe I can build a proven track record that I can later use. My style is pair trading UK & US stocks, I use a combination of brokers - Interactive Brokers & IG markets to execute my trades, use a pair trading program for buy and sell signals and I have strict money management guidelines. I mostly stick to a rules-based trading system but use a little discretion. Currently on my radar, I have 72 NYSE stock pairs & 44 LSE stock pairs that are highly correlated and from various industries. I will list all my entry & exit prices during the market day or after market close.
Wish me luck

Trade entered; UK stock pair SMDR vs DGO, two oil & gas exploration & production companies, correlation is high at 91% and the ratio chart is almost at a 200 day high.

Long Entry SMDR - 106.00

Short Entry DGO - 159.50

That's absolutely brilliant Maybe I can use this as empirical evidence in my dissertation. I was intending to write about the long/short strategy. Good luck to you, I hope you bucket loads

mhp123 said:

That's absolutely brilliant Maybe I can use this as empirical evidence in my dissertation. I was intending to write about the long/short strategy. Good luck to you, I hope you bucket loads

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Thanks, yes by all means use this as evidence in your thesis. Are you a student? Maybe you can prove all those efficient market theory professor's their wrong!

lol, let's hope so. I'm studying Economics, final year.

Just thought id post a quick explanation of pair trading to those of you who don't know what it is;

The pairs trade was developed in the late 1980s by quantitative analysts and pioneered by Gerald Bamberger while at Morgan Stanley. With the help of others at Morgan Stanley at the time, including Nunzio Tartaglia, Bamberger found that certain securities, often competitors in the same sector, were correlated in their day-to-day price movements. When the correlation broke down, i.e. one stock traded up while the other traded down, they would sell the outperforming stock and buy the underperforming one, betting that the "spread" between the two would eventually converge.

The pairs trade helps to hedge sector and market risk. For example, if the market as a whole crashes and your two stocks plummet along with it, you should experience a gain on the short position and a negating loss on the long position, leaving your profit close to zero in spite of the large move. In a pairs trade, you are not making a bet on the direction of the stocks in absolute terms, but on the direction of the stocks relative to each other.

Pairs trade - Wikipedia, the free encyclopedia

Entered a trade on the NYSE, two shipping companies Overseas Shipholding Group Inc. (OSG) & Teekay Tankers Ltd. (TNK). I can see the ratio chart approaching the support zone plus there is a divergence between the RSI & ratio chart and high correlation at 94.71%

Long Entry OSG - 35.76

Short Entry TNK - 11.81

Opened another US trade on Monday,

Long Entry UA - 16.79

Short Entry BEBE - 5.80

This pair is from the apparel clothing industry and currently showing a ratio/rsi divergence.

Hi stocktrader77,
A potentially interesting thread!
A few questions if I may . . .
1. It looks as if your 'pair trade finder' software produces the pairs to trade and then you select suitable candidates from that shortlist - is this correct?
2. If - as you imply - the software produces buy and sell signals, could the whole process be automated, eradicating the need for any discretionary input?
3. I think you said you've around 70 U.S. pairs on your shortlist - how do you then decide which pair (or pairs plural) to trade? If you don't want to reveal too much about your own specific strategy, could you suggest the sorts of things that members who are following your thread might look for - i.e. what are the possible discretionary elements to the trade?
4. For most TA based traders here, timing the entry is very important. Once your selection is made, does timing play any part in the decision making process?
5. Given the hedging aspect of the trade, the risk is (theoretically) much reduced compared to a single directional trade. Do you increase the size of positions accordingly?
6. Following on from the above, do you close out the trade when the 'divergence' has been corrected and the pair are moving in tandem again?
I think that's enough for now!
Cheers,
Tim.

Hi Tim, yeah you can use the backtester to find suitable pairs and then save them to your console. im sure it could be automated someway, not sure, you will have to email them. they advise to only trade pairs above 80% correlation and increasing with a non-trending ratio chart and rsi/ratio divergence, but not all these are strict filters, i like to keep a portfolio of different pairs from different industries, i mitigate risk through diversification and postion sizing. The only TA i use is looking for ratio/RSI divergences and making sure the ratio chart is in a trading range, then i just plain out take the entry and exit signals, the only discretion is in choosing what entry signals to take. yes you can use more leverage pair trading than directional trading. i also check the stock news on the day of an entry signal and see if earnings are about to be released, you don't want put on a position too close to earnings. so each day i have audio alerts set on and when i hear an entry signal, i look at the charts, if i like it, which is about 1 out of every 3 signals, i then place the trade and wait for a exit signal alert, rinse and repeat.

Keeping busy How long before you close your position? Any specific way/reasoning?

mhp123 said:

Keeping busy How long before you close your position? Any specific way/reasoning?

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Generally the trades last on average about 5-10 days, I don't decide myself when to exit a trade I simply wait for a exit signal from pairtrade finder. All im concentrating on is filtering through the entry signals each day and picking good trades to take, keeping good risk management and consistent application of the same method every day.

Hello ST - interesting thread and I look forward to seeing how you get on over the coming weeks.

Are you using the free demo of PairTrade Finder, or have you purchased the software already? I am doing some background research before I try the demo out, with a view to using it longer term.

If you have been using it long-term, what has your ROI been like?

I would also be interested in hearing about your money management strategy for pairs trading.

Thanks Pokerbrat, yes i purchased pairtrade finder quite awhile back. I couldn't trade without it, there is quite a few of us ex-bank traders using it, the guy who developed it was a quant with Macquarie and has really nailed it with this piece. last year I ended up 148%, gunning for 200% this year, but at the end of the day the market will give you what the market will give you. your return is a function of your discipline, risk tolerance, objectives, use of leverage, number of trades taken and general market conditions. Money management is simple, never put more than 25% of my account into any given position. and never have concentrated exposure, spread the risk across many industries always staying market neutral.

opened this trade last night, another US shipping pair,

Long Entry SFL - 10.94

Short Entry VLCCF - 16.54

Ratio chart is oversold and at the bottom of its recent trading range.

stocktrader77 said:

at the end of the day the market will give you what the market will give you. your return is a function of your discipline, risk tolerance, objectives, use of leverage, number of trades taken and general market conditions.

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I appreciate that ST - entry is only a small part of a profitable system.

Couple more questions:

1) How are you trading these pairs, via CFD's or Spreadbetting?
2) When you say 25%, do you mean 25% of your margin or you risk 25% of your capital?
3) How do you manage losses, does PairTrade Finder give you exit signals on a loss making trade as well, or do you have some hard stops in place? If you do what do you base them on?

Appreciate your time on this ST.

I use direct equities and CFD's. Risk management is 25% of my account, for example $100,000 account = have no more than $25,000 exposure in any one position. We don't use stop losses for pair trading, risk is mitigated through staying market neutral, spread out risk and prudent position sizing, only close a position on an exit signal which occurs when the pair comes back to its mean, profit or loss. stops actually decrease performance and your a sitting duck if you use them, for the brokers, market makers, day traders and other shady operators.

Hi stocktrader77,

stocktrader77 said:

. . . We don't use stop losses for pair trading, risk is mitigated through staying market neutral, spread out risk and prudent position sizing, only close a position on an exit signal which occurs when the pair comes back to its mean, profit or loss.

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What happens if the pair continue to diverge, rather than to revert back to the mean? Do you literally sit tight and pray that there hasn't been a seismic shift in the funnymentals causing a split in the correlation of the pair? I guess what I'm trying to say is that, without stops in place on every trade, are you not running the risk that sooner or later you're going to be taken out by a black swan event?

stocktrader77 said:

stops actually decrease performance and your a sitting duck if you use them, for the brokers, market makers, day traders and other shady operators.

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How to win friends and influence people!
I feel a spot of blackmail coming on here! I could arrange for every day trading member of T2W to spam you to death, unless of course it was in my interests not to . . .
:cheesy:
Tim.

yes every now and then you find yourself in an ugly trade, thats just trading, having small positions relative to your account size is the key to mitigate black swan event risk. I have nothing against day traders, I use to be one myself, I was just saying they know where the majority of stops lye and they will gun for them, ive seen it in the flesh, but if someone can trade successfully with stops, kudos to them.

Entered two new trades

Long Entry BEZ - 13.01

Short Entry AIMC - 7.25
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Long Entry CMCSA - 13.74

Short Entry SJR - 16.51

Both are US pairs.