Do you want to learn pair trading? Follow this setup
Around a month ago I
wrote a recommendation to short CCL and buy RCL when the price
difference was close to 0 using a 0.85 spread ratio. At the end of last week the
spread reached 0 and moved through it to a high of 0.42, not quite to our stop
loss. One thing that experienced pair traders do when things come close to their
stop loss is analyze the underlying stocks to see what is causing the movement
in the pair. By looking at the individual stock charts we can get a better idea
of where to hold our stops. Generally, if the stock misbehaves, we exit the
whole pair and keep our money.
Here is a three-month chart for CCL:
In this case, notice that
(
CCL |
Quote |
Chart |
News |
PowerRating) is on a down trend and recently pulled up to
the $50 number. Breaking through the $50 number without a move up from
(
RCL |
Quote |
Chart |
News |
PowerRating)
would cause me to stop out of this trade. If RCL does start to move up to bring
the spread in I would not stop out at $50, but would at $51.75 unless I am
profitable on the spread. If I am profitable on the spread it means that there
has been a turn and the relative valuations are starting to come in line.
Now here is a 1-year chart of RCL:
It is easy to see here how it is the downward movement of RCL that has been
moving the spread. At this point RCL has a 52 week low of 40.72, so I would be
looking at stopping out below 40.50. If RCL does not form this low and CCL does
not go through the 50 then I would be sticking with the trade and giving it as
much time as possible.
At the extremes the CCL will be $50 and RCL will be $40.50 and our spread price
would be $2. There is a small probability of this happening, but if you are
going to risk this much you must make sure that you are willing to hold on for
enough profits to make it worth your while.
For more information visit our website at www.pairtrader.com
Darren Clifford
Darren Clifford is a professional equities
trader with Bright Trading. Mr. Clifford has recently been ranked one of the top
30 traders under 30 by Trader Monthly magazine.
Mr. Clifford holds a masters degree in Economics from Simon Fraser University
specializing in Financial Mathematical Modeling. He is also the president of
www.pairtrader.com, company dedicated to providing the tools and data necessary
for hedged equity trading.