Pair Trading Works For Both Stocks And Currencies In Reducing Risk
Download this 1 Minute Forex Trading System FREE that makes money anytime instantly. Get this shocking Setti Ponti System FREE PDF. This poweful PDF is a gift from Tom Strignano, an Ex-Chief Bank Trader who is famous for releasing FREE PDFs on his proprietary trading systems. Read the story of Richard Samuels, a post office mailman with a head injury and how he made a fortune with these Neutrino Forex Signals. You might have come across the pair trading strategy. Infact pair trading is highly popular among stock traders. You simultaneously take a long position in one stock and a short position in another similar stock in equal dollar amounts to hedge your risk by benefiting from a dislocation between the two stocks.
What you do is try to find two stocks in the same industry and the same sector with a strong historical correlation between them. Yet for the time being, these two stocks are experiencing dislocation with one stock higher in price as compared to the other stock. Overtime, both the stocks are going to converge to the same price level.
You benefit from this convergence by going short on the higher priced stock and going long on the lower priced stocks. So when both the stocks converge, you make profit. If both don’t converge, you don’t lose much. So in pair trading, you try to profit from the convergence of the two stock prices to the historical levels.
Now this same strategy can be used in currency trading. The good thing in currency trading is that you don’t have to buy two separate currencies. Pair trading is sort of in build in it as you can only trade currency pairs meaning you can go short on one and long on another or the other way around.
When you do pair trading, you strip out the influence of the market on the two securities as both the securities have strong correlations and the market effect cancels when both the securities move as you are long on one and short on another.
Now currencies are highly susceptible to broader economic fundamentals like sovereign debt, trade balance, trade protectionism, broader global economic policy actions so by trading two currencies from the same region in a pair can hedge your risk a lot.
Japanese Yen (JPY) was a popular carry trading currency. Traders were happy selling JPY and buying another high yielding currency like AUD. But in 2009, carry traders lost their risk appetite and suddenly started unwinding their yen positions. This massive buying back of JPY made JPY appreciate. So this appreciation of JPY is short term.
Korean economy is closely tied to the Japanese economy with its Won doing well but you can profit from this short term divergence in JPY and Won by trading the pair JPYKRW. Similarly you can pair trade Euro and Pound!
