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Table Of Contents Motivation........................................................................................3 The Mystery Surrounding Hedge Funds........................................4 The Truth About Short Selling.........................................................6 The Controversy....................................................................6 Short Selling and Brokers......................................................7 How to Trade Rival Stocks.............................................................9 Where to Find the Competitors.............................................9 The Cola Wars.....................................................................10 Powerful Solution..........................................................................13 Pick the Right Rivals............................................................13 Portfolio Performance..........................................................18 Alerts....................................................................................21 Black-Box System Revealed........................................................23 More Insights................................................................................25 Correlation...........................................................................25 Equity Curve........................................................................27 Trimmed Rival Stocks Strategy (Only Longs).....................27 Unexplored by Hedge Funds........................................................29
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Motivation This book is a comprehensive guide to a very profitable stock trading strategy that is largely traded by hedge funds, but has been kept a secret from retail traders for decades. Instead of buying individual stocks, this sophisticated method is about buying one stock and short selling another stock at the same time. For specific reasons – covered in detail later in the book – the pair of stocks belongs to companies who are close rivals in the same market. The goal is to stay market neutral, i.e. resistant to unexpected events, wild market moves, corrections or recession. In this style of trading, we are interested in the relative performance of two rival stocks, not in the overall economic situation. High profitability doesn't come from picking small volatile stocks, but rather from trading rock-solid stocks in a very unusual way – exploiting rare trading opportunities among thousands of stocks and entering and exiting positions several times per year. And the best part of it? It won't take you more than a few minutes per month! No matter whether you're a beginner or a professional trader, this book is written for everyone who is looking for a definite and proven strategy explained in simple words. We start with a brief talk about short selling and common issues with brokers. We show you how trades are recognized and how to calculate shares and profits with a typical example of rival stocks: Coca-Cola and Pepsi. The next half of the book is dedicated to a powerful software solution that scans the whole stock market to find the best pairs among all rival stocks, backtests each pair and sends signals just before the market opens. While hedge funds focus on helping the super-rich continue to get richer, it's our mission to help the rest. You are free to share this book with anyone you like!
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The Mystery Surrounding Hedge Funds In the financial media, you often read about stock recommendations from the top hedge fund managers. “Warren Buffett's top pick is Coca-Cola!” “George Soros invests in Charles Schwab!” Whether fund managers like it or not, we all know which stocks they're currently holding. How? Hedge funds are required by law to file this information with the SEC (Securities and Exchange Commission) each quarter. The media are free to publish these stock picks and ordinary investors are free to copy them. In doing so, however, investors may be missing the big picture of what hedge funds are actually doing. The fact that a hedge fund manager buys a particular stock does not always mean that he is betting on its rise. It can be much trickier than that. In order to protect themselves against sudden changes in the market, hedge funds hold short positions alongside the usual long positions. Hence the word “hedge” in hedge fund. This is why hedge funds can break even or even remain profitable when times get tough. The combination of long and short positions gives a different perspective – it's not about betting on the rise or fall of a stock. What really matters is the price difference between stocks on the long side and stocks on the short side. To complete the picture, we explain how you can incorporate hedging into your own stock trading. 1) Shorting the S&P. Most of the time, investors would consider you crazy if you told them you were shorting the S&P, i.e. betting on the fall of the top 500 U. S. companies. From time to time, George Soros is short the S&P in a big way and he knows what he is doing (or at least his team of 100 talented PhD's know something). Don't get me wrong – you're not going to bet on the decline of your own stock portfolio. Smart traders just open a variable short position against the market, so the losses in their portfolio are partly or completely covered during a recession. Increasing the short position during uncertain times (or “hedging in”) is part of this strategy. The disadvantage of this approach is that it can also cut profits if you don't have enough experience of hedging. The following methods
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are far more effective. 2) Shorting overvalued stocks. Typical investors generally focus on buying undervalued or rising stocks, but hunting overvalued or falling stocks is less common among the general public. You can focus on bad stocks as well as healthy stocks. You can look for poor earnings as well as good earnings. Looking for signals that a company is having trouble and then shorting the company is no more complicated than picking companies with great potential. By creating a balanced portfolio of stocks on both the long and short side, you don't have to worry about the overall economic situation. Whether the economy is growing or contracting will always be good news for part of your stock portfolio. This is what we call being market neutral.
3) Trading stocks in pairs. This is the sophisticated strategy largely employed by hedge funds. Until recently, it was inaccessible to retail traders or investors. This was partly because of the lack of affordable technology, but mainly because the essential details were such a wellkept secret. The key is to always buy one stock and sell another stock short at the same time. The stocks must belong to rival companies, i.e. competitors who offer similar products or services. The long and short positions are entered with equal dollar amounts in order to remain market neutral. In the rest of this book, we reveal all the details as well as how you can use software to trade this very profitable strategy.
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The Truth About Short Selling The Controversy The controversy around short selling is as old as the markets themselves. You probably know the story of how George Soros made one billion dollars shorting the British pound in 1992. The billionaire Bill Ackman claimed he is short Herbalife, arguing that it is a pyramid scheme that will collapse. One independent trader told the media: "I go to bed every night and I pray for another recession." Is short selling evil? Many investors hate short sellers because they see them as people who are rooting for others to fail. It stands to reason that investors would not be fans of short sellers who are on the opposite side of the trade. In particular, immature investors expect to multiply their investments by holding the “recommended� stocks, and they often want to see unrealistic growth within a short period of time. When things don't go their way, they're always looking for someone to blame. And their usual targets are short sellers. At times, this can even appear as government propaganda. For example, when the Chinese stock market crashed and 3.2 trillion of value was erased in three weeks, Chinese mainstream media were quick to blame foreign short sellers. Be a proud short seller! While investors drive stock prices higher, short sellers push them down. Without short sellers, some stocks would skyrocket to ridiculously high levels, only to
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crash later. Short sellers keep an eye out for things like fraud, corporate disasters, misleading accounting, hype, aggressive stock promotion and overpriced stocks in general. They protect the market from overly optimistic investors who wouldn't hesitate to buy an overpriced stock and drive the price even higher. They are motivated to expose the truth about mismanaged companies; to uncover dirty practices and save investors money. Short selling is an inevitable component of a well-functioning market. Short selling is also an essential part of the profitable strategy we’re going to reveal in this book. We focus on stocks that suddenly outperform their rivals (or whose rivals underperform). We sell short the outperforming stock and buy its rival at the same time. When the prices converge to their normal levels (which usually happens within a few days), we exit our long and short positions to make a profit.
Short Selling and Brokers Not all stocks can be sold short. You can sell a stock short only if it's available for short sale from the broker. A stock that can be sold short is called shortable or Easy To Borrow (ETB). The opposite is Hard To Borrow (HTB). You will do best with brokers that have the largest lists of shortable stocks. Because short selling has become more popular in the recent years, and because technology is advancing so rapidly, it’s unwise to rely on broker reviews that are more than one year old. Brokers that were once poor at short selling are now offering thousands of shortable stocks. The mechanism behind short selling The mechanism behind short selling can be a little confusing: you are selling a stock that you don't own. When you want to sell a stock short, what you actually do is borrow it from your broker, hence the term Easy To Borrow. The broker's task is to find someone who owns the stock. This means that some stocks are either not easy to sell short, or they can be sold short but only with a limited amount of shares. You sell the borrowed shares, and later you close the short position by buying back the same amount of shares. Finally, the stock is returned to your broker. If the price drops, you buy it back at a lower price,
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making a profit. In practice, provided that a stock is Easy To Borrow, short selling is as easy as buying − just a click away! Liquid stocks are shortable Some brokers maintain an Easy To Borrow list where you can check whether a particular stock is shortable at any given time. Generally, a stock with a daily volume of at least 300K has a good chance of being shortable. As we select only liquid stocks with our strategy, almost all of them should be shortable. Account requirements There are two types of brokerage accounts for trading stocks: a cash account and a margin account. Cash Account No leverage Minimum depends on broker
Pattern Day Trading
Stock Account Margin Account Typical leverage 2:1 Minimum by law: $2,000
Mimimum by law: $25,000
Non-Pattern Day Trading (holding position overnight)
For short selling, you need a margin account. The typical leverage for holding a position overnight is 2:1. This means that with a $2,000 account you can buy $4,000 worth of stock shares. Because we hold all positions overnight (each trade lasts several days), we are not pattern day traders. By the way, the rule requiring a minimum account of $25,000 in order to day trade came into effect in 2001 with the collapse of the dot-com bubble. The bubble was caused by overexcited immature investors buying stocks like crazy. Do I need a margin account to trade the Rival Stocks Strategy? The good news is: if you want to trade stocks with an account below $2,000, you can still trade our “Trimmed Rival Stocks Strategy (Only Longs)” with a cash account! With some brokers, you can open a cash account as low as $500. The trimmed strategy is explained in the last chapter of this book. You can also use
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it if you have trouble shorting stocks with your broker or at times when short selling is restricted.
How to Trade Rival Stocks Where to Find the Competitors Rival stocks are the stocks of competing companies. You can check out the direct competitors of any stock on Yahoo by following the steps below. Step 1. Go to http://finance.yahoo.com Step 2. Search for the particular stock whose competitors you want to find. For example, Apple (AAPL):
Step 3. You will see some data and a price chart. Scroll down the page to see some of Apple's competitors.
Here, you can see that Google (GOOG) and Hewlett Packard (HPQ) are Apple's most significant competitors. Obviously, Apple has far more than two competitors. Those listed here are simply the most prominent ones, or simply companies that give Apple the most cause for concern. How do we find the rest? All the stocks listed on major exchanges are divided into sectors and industry groups. The following Yahoo page displays a list of all sectors: http://biz.yahoo.com/p/ When you click on a sector (for example, Consumer Goods), you see all the
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industries within that sector.
When you click on a specific industry, you see all the companies producing goods or providing services in that industry. Companies from the same industry group that are big enough and based in the same country can be considered competitors.
The Cola Wars To get a rough idea of how the Rival Stocks strategy works, let's look at two well-known competitors: Coca-Cola (KO) and Pepsi (PEP). Because Coca-Cola and Pepsi are very close competitors, their stock prices move in a similar fashion. Their daily Yahoo charts are shown together below.
The charts are not perfectly equal, but you'll notice that prices move up and down at almost the same time. Sometimes one stock outperforms the other, at other times they move closer together. A certain bunch of traders takes
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advantage of these fundamental movements, making a profit from this simple observation alone. Let's take a closer look at what they do.
Here is one example of a typical trade. At the first circled spot, Coca-Cola is extremely overbought compared to Pepsi, so we sell-short Coca-Cola and buy Pepsi at the same time. An abnormal increase in the difference between stock prices is called divergence. After a few days, stock prices move closer to each other (in our example, the price lines even cross). This is called convergence. Divergence and convergence repeat over and over again, providing great trading opportunities. The rule is simple: enter at divergence and exit at convergence.
Details of where exactly to enter and where to exit will be revealed later in the book. For now, let's calculate the profit of this sample trade. Entry and exit prices are as follows:
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Stock
Direction
Entry Price
Exit Price
Coca-Cola (KO)
Short
44.55
40.68
Pepsi (PEP)
Long
93.94
93.73
Now the tricky part. Remember why we want to stay market neutral? We want to hold equal capital on the long and short side to hedge against fundamentals, recession and other unpredictable market phenomena that might cause prices to fall across the entire beverage industry. Notice that Pepsi stock is more expensive than Coca-Cola stock. In this case, we have to buy more shares in Coca-Cola than in Pepsi in order to get the equal dollar amount. How much exactly? Let's say we invest $5,000 in each stock. Stock
Investment
Number Of Shares
Coca-Cola (KO)
$5,000
5,000 / 44.55 = 112 (approx.)
Pepsi (PEP)
$5,000
5,000 / 93.94 = 53 (approx.)
By short selling 112 Coca-Cola shares and buying 53 of Pepsi, we'll be holding almost equal amounts of capital on both the long and the short side. If either stock rises or falls – let's say 5% – at the same time, it won't affect our portfolio equity at all. Relative price moves are all that matter. So, what is the profit? Stock
Direction
Profit Per Share
Shares Profit / Loss
Coca-Cola (KO)
Short
44.55 – 40.68 = 3.87
112
Pepsi (PEP)
Long
93.73 – 93.94 = -0.21 53
3.87 * 112 = 433.44 -0.21 * 53 = -11.13 Total: 422.31
The total profit is $422.31. Notice that the profit came primarily from short selling Coca-Cola while Pepsi made a small loss. With pair trading, you're not bothered about whether individual stocks end up making a profit or a loss. Sometimes both stocks are profitable; sometimes one stock covers the loss of the other. We consider it a single trade and from this perspective, it's a winning trade. On a standard cash account with no leverage, $422.31 profit on a $10,000 investment represents a return of 4.2%.
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Remember that we invested $5,000 on each of the two stocks, which is $10,000 in total. Most stock brokers offer a margin account with leverage of 2:1, so you would actually use $5,000 in real cash to trade the same amount of shares as above. That's $422.31 profit on a $5,000 investment which means a return of 8.4%. Since its inception, the average annual return of the S&P has been approximately 10%. We made an 8.4% return on a single trade lasting less than two weeks, and we didn't pick any explosive stocks – just those “boring” old giants Coca-Cola and Pepsi. Plenty of similar trading opportunities exist throughout the year between many other pairs of rival companies, thus making it possible to achieve high annual returns. We don't watch the economic news and we don't over-analyze. We make a profit when two rival stocks diverge and converge, and we do it many times a year. However, not all pairs of rival stocks provide acceptable performance, so we are very selective about picking the right pairs. We need to backtest each potential pair very carefully, and this is where our cutting-edge technology comes in.
Powerful Solution Pick the Right Rivals There are thousands of well-capitalized companies on the major stock exchanges. By selecting pairs from the same industry, we analyze tens of thousands of rival stocks! Each pair is backtested over the last 10 years. The precise strategy for entering and exiting is explained in the chapter entitled Black-Box System Revealed. It’s all done by the sophisticated software running on our high-end servers. The results are readily available in a userfriendly interface which allows you to pick the top performing pairs.
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The pairs on the screenshot above are sorted by maximum drawdown (the most consistently rising equity curve), so the best pairs are always on top. For each pair, you can see the equity curve, industry and many other useful statistics including winning percentage, average trade, profit factor, etc.
Use the Filter to choose a different backtest interval, select exchanges, market capitalization, daily volume, winning percentage, sorting method, and so on.
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When you click the Update button, the pairs in our database are instantly filtered to display the best of the best. For beginners, we recommend you keep the default setup as it has been proven to obtain the best results. The first step is to select the best pairs by clicking on the plus sign.
You are looking for pairs that have a nice smooth equity curve. Don't be greedy, be selective! We recommend you select a maximum of 12 pairs. Hovering the mouse over the equity curve will give you a quick overview of how the pairs performed over the last 1, 5 and 10 years.
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The ideal pair has a smoothly rising equity curve over the last 5 and 10 years, and it has also been consistently profitable for the last year. Performance over the last 5 years is the most important, so this is where you should focus first. A useful shortcut is to automatically select the top pairs in the current view.
Although it may seem like a super lazy way of preparing your pairs portfolio, it is actually the right way. Simply selecting the top pairs while using the default filter will get you the results you need. The best things are the simplest! Just remember, not all stocks are shortable. Using the default filter, all the stocks have an average daily volume of above 100,000, so most of them are shortable. Check each stock with your broker. If he provides a list of shortable or “easy to borrow� stocks, it may look like this:
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In the example above, EOI is not shortable, so we would uncheck the pair EOI / EOS. Keep in mind that the list of shortable stocks is dynamic and it updates every day (though not dramatically). If your broker doesn't provide this type of list, you will find out whether or not a stock is shortable the moment you attempt to trade it, because your order won't be executed. So when you receive a trading signal, always start executing the order with the stock on the short side. If the order doesn't go through, never mind, just miss the trade. If you have trouble shorting too many stocks, we recommend you increase the Average Volume to 300,000.
Stocks with average trade volume above 300,000 have a pretty good chance of being shortable. The EOI we tried above was not shortable because its average volume was only 110,000.
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Small volume, probably not shortable
Large volume, probably shortable
Brokers improve quickly and these issues change dramatically over the months and years. Once you've selected the pairs, you can keep the list unchanged for one to three months. During this period, you'll receive trading signals for the selected pairs. After this period, you update the list with the top performing pairs at that particular time.
Portfolio Performance Now that the “hardest� part is behind us, let's have some fun. Let's look at portfolio performance and see how all the selected pairs performed over the last 5 or 10 years.
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On the right, we find some useful statistics including the number of trades, average trade duration and maximum drawdown. When multiple equity curves are added together, the final equity curve smoothes out and the drawdown is lower. This is the power of diversification. On the same page, there's a little setup where you enter account size and the investment per pair.
For example, if your account size is 5,000 USD and the investment per pair is 20%, you allocate 1,000 USD per pair on each trade. With leverage 2:1, you buy 1,000 USD worth of stock and sell short the same amount. This allows you to hold a maximum 5 pairs simultaneously (or 10 individual stock positions). If your account is fully allocated and you get a trading signal for the 6 th pair, you simply miss that trade. The number of missed trades is calculated in the statistics.
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Another example: if you allocate 8% investment per pair, you can have all 12 pairs from your portfolio allocated in case such a coincidence occurs. With a setup like this, you will never miss a trade, but the net profit will also decrease. On the other hand, if you allocate 50% investment per pair, you can hold a maximum of 2 pairs (or 4 stocks) simultaneously. Your money will be working most of the time and you will miss most trades:
The total net profit will increase, but so will the drawdown! Here is the comparison. Conservative Approach
Aggressive Approach
Investment per Pair
Low (e.g. 8%)
High (e.g. 50%)
Number of Trades
Higher
Lower
Number of Missed Trades
Lower
Higher
Total Net Profit
Lower
Higher
Max. Drawdown
Lower
Higher (!)
In other words, you will trade your account more effectively if you take an aggressive approach – less trades and higher profit. The downside is that the drawdown will also increase because there will be less trades to smooth the equity curve. You will give up the power of diversification! We recommend you choose something between a conservative and an aggressive approach (20%), but feel free to play around with it.
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The best part – compounding As your account grows, you can trade more shares, thus making you more profit and enabling you to trade more shares, and so on. To see how much you would make by reinvesting your money, check the Compounding box.
Equity would grow exponentially and the Total Net Profit would increase 14 times! Compounding is the way rich people built their wealth. Starting with a relatively small account, you would become a multimillionaire in 10 years:
...or, at very least, you would get relatively wealthy on the way. Forget the S&P benchmark – this is the way to make high returns in stock trading! Note that our equity curve didn't even notice the big S&P corrections or the financial crisis.
Alerts Daily trading signals come out on the Alerts page a few minutes before the stock market opens.
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Each entry signal consists of one stock to buy and one stock to sell short. The number of shares is automatically calculated from the Investment per Pair input. Relax, there is no need to hurry, the trade lasts for several days. Either check the member's area for new signals once a day, or simply receive the signals to your mailbox. You can get an idea about the frequency of alerts from the Portfolio statistics. For example, 585 trades in the last 5 years is the equivalent of about 10 trades per month, or 2 to 3 trades per week. You can increase the number of trades by selecting more pairs. However, we recommend you avoid over-trading – just pick the best of the best. The Rival Stocks system puts you light years ahead of the crowd. It allows you to avoid the constant stress of reacting to unforeseen events, of getting bogged down by information smog and having to track your stock portfolio countless times a day. Instead you can sit back and watch Bloomberg or CNBC for the pure fun of it, safe in the knowledge that you have a clear proven strategy that's resistant to the everyday problems of the world.
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Black-Box System Revealed Years ago, this strategy was known only to the inner elites: fund managers, bankers, institutional traders, and also to programmers working for financial institutions. In this chapter, we reveal all the mathematical details of how our system works, i.e. when two rival stocks are considered overbought and oversold and when they converge to normal levels. You don't need to learn this stuff because our system does the job for you. We just want to share our knowledge! When you click on the Backtest Chart in the list of pairs, you see the historical trades marked with red and blue arrows. The arrows appear over the specific indicators listed below.
•
The black line is the ratio of closing prices plotted for each trading day. For example, if FBMI costs $17.84 and KEY costs $13.79 at the end of the day, the ratio is 17.84 / 14.79 = 1.2936...
•
The purple line is the simple moving average with period 15 applied on the ratio.
•
The light blue lines define an area of probability in which the ratio is
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trapped most of the time. This is the so called Standard Deviation of the ratio. In our case, two Standard Deviations are used. You will observe that when the ratio reaches the upper or lower band (light blue), it tends to reverse back to the moving average (purple). These are good entry signals. The rules are as follows: •
A low ratio means that stock A is underperforming stock B. When the ratio crosses the lower band, open a long position, i.e. buy stock A and sell short stock B. This is represented by the blue arrow.
•
A high ratio means that stock A is outperforming stock B. When the ratio crosses the upper band, open a short position, i.e. sell short stock A and buy stock B. This is represented by the red arrow.
•
When the ratio crosses the moving average, exit the position. Exiting a long position is represented by a blue cross. Exiting a short position is represented by a red cross.
•
Hold the position for a maximum of 21 days.
When we talk about the “long position” of a pair, we actually mean a group of two positions: stock A on the long side and stock B on the short side. Opening a “short position” of a pair means the opposite – selling stock A short and buying stock B. We believe that the pair trading strategy will make sense to you. It's all about spotting the extreme areas where stock prices normally don't go, and exiting when they revert back to normal levels. One more thing to note: all calculations are based on the closing prices. When the stock market closes, our servers start working hard to generate signals ready for you to open a trade the following day when the market opens (or a little later). For this reason, slight discrepancies between the backtest entry point and the real entry point may occur. Whether or not the opening price on the following day is different from the previous day's closing price is no big deal, because we hold positions for about 10 days on average. Moreover, as both rival stocks tend to rise or fall simultaneously outside the regular session, you will usually get a better entry price for one of the two stocks.
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More Insights This chapter presents more insights for advanced traders. Although you'll do well even if you skip this chapter, using the tips below will result in a robust portfolio of pairs that will continue to perform well into the future.
Correlation Correlation is a statistical measure of how two stocks move in relation to each other. It represents a value between -100% and +100% (or -1 and +1). Two perfectly correlated stocks with 100% correlation would have identical price charts. Two negatively correlated stocks with -100% correlation would always move in the opposite direction. Stocks with zero correlation (0%) are unrelated. In our example, Coca-Cola and Pepsi have a very high correlation of 92%. Their stock prices move in a very similar fashion because they are such close competitors. The pairs we're interested in should not only have good backtest results, but their respective stocks should be positively correlated as well. You can see the Correlation and Average Correlation values in the list of pairs below.
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Positive correlation usually applies automatically to the stocks of rival companies that have good backtest results, which is why we weren't bothered about the correlation when picking our pairs. However, it is recommended that you pick pairs with correlation and average correlation of at least 60%. This would narrow the portfolio down to wildly competing pairs of stock. Clicking on the correlation number opens a chart of historical correlation values.
Here you can be more subjective and narrow down the pairs even more to remove the ones with correlation that looks inconsistent or has significantly decreased over the last year. The example correlation chart below doesn't look good at all.
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Equity Curve When you click on the equity picture, the detailed equity curve pops up. You can also view the equity curves for Long/Short trades and Short/Long trades separately. Long/Short trades are pair trades where you buy stock A and sell short stock B, and vice versa.
It's wise to check whether or not both trade directions have contributed to the total equity curve. If a pair is not profitable in either case, don't select that pair.
Trimmed Rival Stocks Strategy (Only Longs) The blue line and the red line running across the green area represent the contribution that individual stocks have made to overall profit. The green equity curve is simply the sum of the blue and red curves. In some cases, both stocks contribute to the total equity curve:
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But in others they don't:
In the example above, only the second stock (the red curve) is responsible for profitability. The first stock (the blue curve) is actually cutting the profits. But the second stock is still useful because it nicely smoothes the total equity curve (in green). Now, the idea is to select only pairs where both individual stocks have a rising equity, i.e. both blue and red curves are rising. Then you can omit trades on the short side. For example, if you received the signal:
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Sell Short GOOG 1 share / Buy AAPL 6 shares you would buy AAPL only and ignore GOOG. This is not the best way to do pair trading (in fact, this isn't really “pair� trading at all), but you could tweak it if you didn't have a margin account or if you couldn't sell short particular stocks. The advantage of not taking short trades is that you can also include hard to borrow stocks that have lower daily volume, but are still safe to trade (above 100,000 volume).
Unexplored by Hedge Funds If, like many people, you're wondering how a mechanical stock trading strategy, implemented by hedge funds and the big guys, could possibly remain effective, all you have to do is look at what happens when you uncheck the Average Volume filter.
The performance of each pair looks unbelievably stable! You may also be
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wondering why pairs of low volume stocks have such eye-catching equity curves. These stocks are illiquid, which means they're not safe to trade. Any trading that is performed can have a significant impact on the stock price. It is recommended that you trade stocks with at least 100,000 average daily volume, which is why these stocks remain untouched by pair traders. Stocks that are liquid to us are not necessarily liquid to hedge funds. Hedge funds operating with billions of dollars and trading huge amounts of shares are not interested in many of the stocks we would trade without hesitation. So we're on a different playing field from the hedge funds. Because the pair trading strategy as presented in this book is little known to retail traders (you are still in the relatively small group of people who know the hedge fund secret), our top pairs remain unexplored, and there is money sitting on the table. With so many good pairs and so many trading opportunities in pair trading, this strategy will work for decades, exactly as it has been working up to now. You are one of the lucky few who not only know about the unfair advantage, but have also discovered the right tool to enter this underexploited region of the trading world!
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CFTC required disclaimer: Trading stocks on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in the stock market you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. CFTC RULE 4.41 - Hypothetical performance results have many inherent limitations. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk. Variables such as the ability to adhere to a particular trading program in spite of trading losses as well as maintaining adequate liquidity are material points which can adversely affect actual real trading results.
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