Using Correlated Stocks as a Leading Indicator: An Applied Pair Trading Strategy Don Bright & Darren Cliffordwww.stocktrading.com www.pairtrader.com
What is a correlated stock? • Statistical vs. intuitive • Some stocks show correlation just because they are both related to the market, not to each other: Spurious correlation. • Want stocks that have an intuitive reason to be correlated. • Same sector • Similar business models • Work with each other in different processes.
Leaders and Followers • Know your stocks: • Which stock is generally the leader in the sector? • Which stock trades more volume? • Any news events to cause leadership for that day?
Quantitative Analysis • Filling in of the opening gap • Average daily ranges • Historical spread movements • Opening only order candidates
Pair Charting • 65 Day to 10,000 day historical pair charts. • Spread range and volume charts. • Basic technical indicators.
Automated Programs • Charting your profits and losses • Gap indications • Automated enveloping program • Opening only strategy • Pair tracking software • Pair charting software • Automated pair layering execution system.
The Setup • Movement in the lead stock is generally followed by a movement in the secondary stock. • Wait for movement in the lead stock and confirmation of continue in move and then trade the secondary stock. • Lead stock rises $0.2 and still shows signs of buyers: buy the secondary stock.
The Exit • Reversal in lead stock. • Movement of the secondary to catch up to the lead stock. • From here, with no sign of more buyers, direction is random. • PRICE ACTION OF LEAD STOCK DEFINES ENTRY AND EXIT.
Extra’s • Movements off the opens • Pair off instead of capitulating on the trade. • Benefits of shorting first. • Benefits of buying first. • Compounding probabilities • Thanks for listening in to the Pairs Trading portion of our discussion. • Don and Darren