This is a pairs setup for you long-term traders…
Digging for black gold
in the oil fields.
Sometimes there are large discrepancies in how
the market views similar companies. This comes from a company being a hot stock
that is attracting a lot of attention from either buyers or sellers. Often times
people become emotional or only invest in companies that are in the news since
that is the only thing they know of. For professional traders this creates
long-term opportunities from fundamental mispricing.
Check out the following situation in the oil and
gas exploration fields:
| FST | KWK | |
| Market Cap | 2.6 B | 2.9 B |
| P/E | 16 | 68 |
| P/TB | 1.82 | 8.51 |
| P/FCF | 9 | – |
Two very similar companies, yet drastic
differences in fundamental valuation between the two. From the summary above
going long
(
FST |
Quote |
Chart |
News |
PowerRating) and short
(
KWK |
Quote |
Chart |
News |
PowerRating) is the long term play.
Looking at the individual charts is important to try and determine what stock
has been misbehaving to consider if it is time for an entry.
First FST:
FST has been going up over the last two years.
This is encouraging to see that the stock you are looking to buy is behaving
normally. The oil market has moved up and so has FST. Waiting for a new high may
be something a longer term trader would consider doing.
Now for KWK:
Looking at the chart of KWK we can see that it has had a tremendous move over
the last two years: Up a whopping 500%. It appears that shorting KWK is where
most of the risk is in this trade. Watching to make sure that KWK does not
continue on this trend is crucial for creating our stop loss parameters.
The ratio used on this trade would be 93, or 14 to 15. Being capitally balanced
in a longer term trade is crucial to maintain your hedge.
Now for the spread charts:
The spread has pulled off the most recent bottom, so any pull back is a place to
go long. It would be a new low that would cause concern. Remember to compound
your probabilities.
So here are some guidelines that I would use trading this:
Entry: Long at 0
Stop: -5
Profit Target: 30
Make sure you manage your capital that you can allocate to this trade, this has
a larger stop then we usually use. It is definitely long term. With the increase
risk though, does come a lot of potential for reward. Once the market gets away
from KWK being the stock of the day, fundamentals should take over and profits
should roll in.
Darren Clifford
For more information visit our website at
www.pairtrader.com
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.