If you trade long-term, consider this setup
Homing in on the Housing
Sector
The last couple of weeks have been examples of
the benefits of hedging within the home building and oil sectors. In the middle
of bull markets no one thinks that anything can go wrong, buy and hold and hold
and hold. During these markets, while stocks are doubling, everyone always asked
why I don’t simply invest and go long stock? The following 6 month chart of DR
Horton
(
DHI |
Quote |
Chart |
News |
PowerRating) homebuilders is a great example of why:
In the last six months DHI has given up nearly
all of its gains retracing roughly 25% from its high of $42. In the markets, as
in all things with life, at some point good things come to an end. Take a look
at one of its peers Hovnanian
(
HOV |
Quote |
Chart |
News |
PowerRating):
In this case HOV has pulled back by more then DHI,
a whopping 36%. Taking one sided positions in stocks just brings too much risk
and unpredictability with it. Here is what the pair chart looks like when you
capitally weight the spread 1.5 DHI to 1 HOV:
Where HOV moved $28 from its low the spread moved
$14 dollars. By being hedged the movement was reduced by half.
Generally with quick market movements some stocks
get emotionally over sold or over bought. On a percentage basis HOV was sold off
more then DHI, was this fundamentally warranted?
From the above information HOV has stronger
simple fundamentals. The market should not have been emotional and oversold it
compared to DHI. Who knows what the direction of the market and sector should
have been and if the sell off was justified in total. What is important to us
here is the relative performance and at this point we should be going short DHI
and long HOV as the emotional money is taken out of the trade.
From a technical basis the spread has formed a
high at $4 and started to retrace. This is good as we don’t like to catch a falling
knife and trade a spread that is forming new highs or new lows. It also allows
for a defined risk reward trade off.
Spread: DHIHOV150
Entry: Short at $2
Stop: $4
Profit Target: trailing stop after -2
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.