For long-term traders, here’s 2 pair trades I like
Matching your strategy with your spread.
Different spreads show different characteristics and have to be traded
differently. When analyzing spreads a crucial question to figure out is if your
spread has a range bound or trending nature?
A range bound spread should have a smaller historical range and show chop back
and forth. The more volatility within a defined range the better the range bound
spread will be as it presents more trading opportunities. Consider the following
65-day chart of Diamond Offshore Drilling
(
DO |
Quote |
Chart |
News |
PowerRating) and Transocean
(
RIG |
Quote |
Chart |
News |
PowerRating)
(DORIG100).
The pair has stayed in a $3 range over the last three months. Looking at a range
bound spread like this the general trading strategy is to be a contrarian and
fade any extensions the spread makes.
A trending spread should show extreme and continued price movement in one
direction. The larger the historical range the more profit potential exists in
these types of spreads. The best way to find spreads like this is to look for
large historical trading ranges and broad movements within them. You don’t want
to find a spread that has only traded within one direction over the last 3000
days. Look for spreads that have trended back and forth. Look at the following
3000-day chart of Lehman Brothers
(
LEH |
Quote |
Chart |
News |
PowerRating) and Morgan Stanley
(
MWD |
Quote |
Chart |
News |
PowerRating)
(LEHMWD50).
Over the last ten years the spread has shown some extreme price swings with over
$75 dollars worth of movement. A spread like this has historically chosen a
direction and continued to move in that direction. This is an ideal type of
spread for trend trading investing.
One thing to notice in this spread is the effect of the bubble on the spread.
The large stock prices caused more dramatic moves in the spread prices and often
time we need to dismiss it from our analysis as we don’t believe we will ever
see those markets again.
This trend has even occurred over a shorter time frame, consider the 65-day
chart of the LEHMWD50 spread:
Over the last 65 days this spread has generally gone up. The range has been over
$9 with the low coming at the beginning of the quarter and the high at the end
of the quarter.
There are many ways to make money in the markets, one of the most important
things a trader can do is apply the right strategy to the right pair. Looking at
historical price actions of pairs does not mean that the price action will
continue, but it gives us a great place to start.
For more information about pair trading visit
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.