Profit from Pairs

Despite a languid share market, two pairs trades highlighted on this blog illustrate the potential for profit from pairs, at lower market risk, regardless of the overall direction of the market. Today’s post looks at the performance of these trades so far.

On April 12 and 13, I posted on pairs trading – going long one share (or commodity, currency, index), and short another share. There are two “live” trades, posted here:

David Jones vs Myer

Woodside vs Oilsearch

The methodology is explained here:

So, how have the trades gone so far? This chart shows the return of the two trades, graphed against the return for the period for Australia 200 index. Please note, the returns on the pairs trades do not take into account trade and financing costs, and assume that the trades where entered at the opening price on the day the trade was blogged:

As you can see, the score (at yesterday’s close) was 1 out of 2.

The Woodside/Oilsearch trade is DOWN 3.3%. Oilsearch announced an increase in gas reserves  based on drilling results – unexpected, and a major positive for the company.

The David Jones / Myer trade is UP 6.7%. Market action suggests that industry wide issues are the key price drivers, and the prices have reverted to a more “normal” relationship.

The Australia 200 index is UP 2.5% for the period.

These results illustrate the key point – profits and losses on pairs trades are not directly related to the direction of the market. While traders are likely to cut WPL and OSH, and run DJS / MYR, other traders take a portfolio approach to pairs, running large numbers of pairs positions.

About michaelmccarthycmc

Chief Market Strategist - CMC Markets and Stockbroking Regular on ABC, BBC, Bloomberg, Channel TEN, CNBC, SBS and SKY
This entry was posted in Market, Shares, Stocks, Trading and tagged , , , , , . Bookmark the permalink.

2 Responses to Profit from Pairs

  1. Vlad says:

    Thank you for this follow up analysis, Michael.

    Yes, 6.7% – 3.3% – costs ~ 2.5%. But the question is for how long to run the pairs. Some pairs traders take profit already at 2-3%. On the other hand, they have tight stop loses.

    So, depending on their profit taking : stop loss ratio they could close DJS/MYR at loss on day 2, take profit in WPL/OSH on day 3, or have them closed now with the opposite results, or have both closed at loss, or both in profit.

    Another interesting observation on this 1 out of 2 result. If we went long outperforming stocks and short underperforming (which is another approach in pairs traiding) the outcome would be the same.

    Well… and when I hear “1 out of 2” I always remember coin tossing…

    • michaelmccarthycmc says:

      Agreed Vlad – each trader will take their own approach, and individual money management rules mean that some traders will have closed both positions some time ago, while others may still be holding one or both. For example, if traders utilise a 3:1 profit loss ratio, with a maximum loss on a pairs position of 1%, they may well have stopped out the energy pair and taken profit on the retail pair. Additionally, a 3:1 profit loss ratio can make a 1 out of 2 proposition profitable, particularly (as you point out) where the % profit is greater than % loss.

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