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Skewing the Pairs Trade To Add Direction
Some spread betters like to construct their pairs trades so that they have a bullish or bearish overall market slant.
- In the Vodafone/MMO2 example if you were slightly bullish towards the overall FTSE 100 you could have bought £5 of the Vodafone and sold short £7.50 MMO2 instead of £10 a point
- If the market were to rally then this trade would likely make more money (than if done is a strict ratio) because you'd obviously lose less on the short MMO2
- But if the overall market were to fall then the trade would likely not make as much as if the two sides were perfectly balanced
Short Term Trading a Pairs Strategy Can Be Expensive
Watch the cost of doing business with pairs trading because you'll be paying away two bid-offer spreads. For day trading they're normally not recommended. Pairs trading is better suited to when you have a view over a week or two, perhaps even longer.
Volatile Markets work well for pair strategies
Everyday pairs trading is often not the way to go because relationships between stocks in the short term can be somewhat fickle. One of the best times to get involved with Pairs is when the markets get volatile and you spot some clear imbalances between stocks within the same sector, or even against the index itself which is discussed below.
Shares Versus Index
- Another way to pairs trade using spread bets is to trade a stock against the underlying index
- For example, buy Barclays and sell short the underlying FTSE 100 spread bet, on the assumption that whatever way the FTSE moves, Barclays share price is likely to outperform
- As ever you have to make sure you get the weightings. of each side correct and you'd do this by a simple percentage analysis
- What is a 1% move in Barclays worth in points versus a 1% move in the FTSE 100?
When To Get Involved In Pairs Trading
When the markets get volatile and certain shares or sectors are sold off heavily then it can be lucrative to trade shares or even sector spread bets against the underlying stock index. With hindsight back in September 2002 when the UK insurance sector was sold heavily would have been an opportune time to buy insurance shares and sell short the FTSE 100. This would have been on the assumption that insurance stocks were very oversold against the overall market.
Advice for Beginning Traders & Pairs Trading
- Pairs trading using spread bets can be very lucrative but can be highly technical
- Traders should only try it when they've got some good experience in trading and spread bets in general
- It is also good advice when you're starting out trading a new strategy to bet in small amounts at first. A spread bet broker like Finspreads offers small betting stakes
- The market and opportune pair trading strategies will always be there
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