The Secret To Finding Profit In Pairs Trading

The Trading Deck features opinions on trading and investing written by market professionals, not staff journalists. He ended up jumping in front of a train. The pair-trading strategy — essentially buying one stock while selling short another within the same sector — sounds good in theory, but it can be a real portfolio killer. When you pair trade stocks, you buy the underperformer, and you sell the outperformer. You are betting on mean reversion. In other words, you think the stock that has fared relatively badly will make up for that over the next period and start outperforming the one that had done well.

In the oil sector, for example, think Exxon Mobil XOM, It is a popular strategy, and the opportunity can be easily spotted on a chart where both stocks are plotted versus each other, i.

They have been stuck in a tight range. They are two well-managed global in a very stable sector, so when one stock underperforms, the other company should catch up sooner or later.

Pairs Trading with Options | Elite Trader

Unfortunately, the reality is that I have seen a lot of people do this kind of pair trading over the past 20 years, but not met any individual traders who have consistently made money doing it. It might be different for computer programs, which trade intraday, but for people without that kind of computer power, it is a loss-making strategy as far as I am concerned.

Why do I think that is the case? Well, first of all, there is normally a good reason why a certain stock outperforms its competitor over a certain period. It might well be a fundamental change in the business, or maybe new management has arrived, or perhaps the two stocks weren't as comparable as first thought.

Here you see the price ratio between General Motors GM, You could argue that they were trading in a range between and , and if you had enough patience a pair trading strategy would have made money. However, it would have given you the position in of being long the underperformer General Motors vs. That position would have lost you all your money as the ratio went to zero when General Motors went bankrupt in So it really would have been a bad strategy to bet on the underperformer being the place to put your money.

Other issues with pair trading are that you pay a lot of commission to your broker, and that the time period of mean reversion might be much longer than you initially hoped for. Also, as the spread goes out further and further, more and more traders will put on this trade just as you did, leading to an enormous consensus position, where all the traders are on the same side of the trade and are all losing money and getting nervous.

The chances are that the spread will go out even further as these traders start to cut their positions. If pair trading can drive a billionaire to suicide , I think that tells you that you should stay away as well.

Keep your life simple — don't do pair trading. By using this site you agree to the Terms of Service , Privacy Policy , and Cookie Policy. Intraday Data provided by SIX Financial Information and subject to terms of use.

Historical and current end-of-day data provided by SIX Financial Information. All quotes are in local exchange time. Real-time last sale data for U. Intraday data delayed at least 15 minutes or per exchange requirements.

WTI crude-oil prices touch session lows on Nymex. Updated Stock market struggles to return to record territory. Time for IMF, eurozone to agree on a real solution for Greek debt crisis.

Drug stocks surge on report that President Trump plans to ease industry regulations. Why Venmo Should Feel Threatened.

Corrected Forget ping pong, this is the hot new work perk. Chesapeake Energy's stock sinks after Macquarie turns bearish. This is why Mattel just gave Ken a man bun. The Rock 'Em Sock 'Em Robots Fight. Updated FTSE ends lower as oil prices fall, pound climbs on rate-hike hopes. Updated Gold prices rise from 5-week lows as dollar eases. FBI Gives Details About Congressional Baseball Shooter.

Home News Viewer Video SectorWatch Podcasts First Take Games Portfolio My MarketWatch. Retirement Retire Here, Not There Encore Taxes How-to Guides Social Security Estate Planning Events Columns Robert Powell's Retirement Portfolio Andrea Coombes's Working Retirement Tools Retirement Planner How long will my money last?

Economy Federal Reserve Capitol Report Economic Report Columns Darrell Delamaide Rex Nutting Tools Economic Calendar. My MarketWatch Watchlist Alerts Games Log In. Home Trading Deck Stocks. By Lex van Dam. We Want to Hear from You Join the conversation Comment. MarketWatch Site Index Topics Help Feedback Newsroom Roster Media Archive Premium Products Mobile. Dow Jones Network WSJ. Royal Dutch Shell PLC ADR Cl A U.

GlaxoSmithKline PLC ADR U.