Pair Strategy Used By Experienced Traders
I have received oodles of attention on my pair trading article and the play I entered in both Apple and Research In Motion
. I went long Apple and short Research In Motion.
The approach of matching a long position with a short position in two stocks of the same sector is called pair trading. This creates a hedge against the sector and the general market that the two stocks are trading in. The hedge made is in essence a wager that you are placing on the two stocks; the stock you are long in opposed to the stock you are short in.
Like its name implies, a pair trading tactic is a double-pronged method, where 2 outwardly disparate option or stock positions are opened at the same time. The strategy can give somewhat of a safety net to guard against an surprising move in a specific sector, while capitalizing on a specific equity's relative-strength backdrop.
Fundamentally, a pair trader hedges his or her bets, opening positions in 2 interconnected equities or indexes and playing them against one another, selecting 1 call (bullish) position and 1 put (bearish) position. The duo of positions then collectively gives money-making returns amid a number of outcomes.
For instance, I had a good feeling regarding Apple, but a pessimistic sentiment about Research In Motion. I went long on Apple whereas I shorted Research In Motion.
I moreover had an uneasy sentiment concerning the whole technology sector. By means of taking a short position in Research In Motion, it allowed me to profit if a large sell off in technology took place. This profit on the short side would offset my losses in Apple on the long side.
Apple maintained its relative strength versus Research In Motion. The shares rallied and the short side of the trade (Research In Motion) fell. Both sides of the paired trade enter positive territory.
But let us say the entire tech sector suffers a large decline. The Research In Motion short is profitable, counter-acting the Apple long position which nets a loss. This is a better outcome than if I only went long on Apple.
You're looking for the percentage change in the market between Apple and Research In Motion to move in Apple's favor no matter which direction Apple or Research In Motion go.
On May 14, 2009, I went short RIMM at $71 and long AAPL at $122. I exited out of the trade on July 10th 2009 with RIMM at $66 and AAPL at $137. I nailed 12% on my AAPL long, and 7% on my RIMM short. So the total gain was 19%.
pair strategyby: Lupie Gonzales.
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