Sector Analysis In Pair Trading

  • August 9, 2005
  • Darren Clifford

When you approach pair
trading don’t throw away your prior experiences, it is good to start
with a sector that you are familiar with. This way you have a head start on how
things work in that sector.

When approaching a new sector it is helpful to find enough companies in the
sector that are actually tradable. Ideally you will find at least 4 stocks in a
sector that have a significant enough trading volume and market capitalization
to trade. When you have too few stocks that make up a sector you can get
anti-correlated pairs as money is moved out of one side of your pair into the
other.

When reviewing a sector you should look for any indexes corresponding
specifically to the sector are present, as well as whom the market leader is in
that sector. Some sectors have regular news events that happen weekly or
monthly. As well you should check to see if there are any legal events or merger
tendencies that affect your stock.

Take a look at the following list of oil companies:

Company
Symbol
Market Cap Average Volume
Exxon Mobil Corp  XOM 370B  17.2M/day
British Petroleum BP  240B 3M/day
Royal Dutch RD 122B   
2.1M/day
Chevron CVX 122B 7.7M/day
Conoco Phillips COP 87B 6.3M/day

Each of these companies trade a significant amount of volume and have a large
enough market cap so that other traders and funds can’t manipulate the price of
the stocks.

You can also use the OIX as an index for the sector to help with determining the
direction and movement of the oil industry.

Get ready to put all of these new skills into practice as we transition into
specific trade ideas.

Daren 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.