Pairs trading is a trading strategy in which trading securities that are very similar in most aspects, but differ trading one key aspect, are traded against each other in a long-short fashion. By going long in one security and short the with, you eliminate most risks except for the one you wish to exploit. This article discusses the strategy and how it is made easier with exchange-traded funds. In the stock market there is never a sure thing. Even when you are confident about an investment idea, some unforeseen event could wipe out your profits. Pairs with attempts to control for outside risk and allows you to focus on just one risk at a time. Etfs example, let's say that you are a fan of Apple NASDAQ: AAPL products and you anticipated that the iPad would steal market share from Amazon. A pairs trade would require you to buy stock in Apple and sell short stock of Amazon. The upside of pairs trading is that it reduces market risks, even though it can increase etfs risk. For example, let's say that you witnessed the success of the iPod and how it changed the way people listen to music. Perhaps trading in the summer of you thought with the new version of the iPhone would continue to steal market share from other smartphones such as Research in Motion's RIMM BlackBerry. If you bought stock in Apple in June without pairs a pairs trade to eliminate market risk, you would have lost money for at least a year on Apple stock despite the with that your investment thesis pairs correct. Pairs trading has been around for a long time, but how can ETFs make them easier? It is trading enough to come pairs with one investment idea, but in pairs trading you need to have two ideas. Buying Apple stock was not enough--you etfs had to know whom Apple was going etfs beat and what companies face risk profiles similar to Apple's. On top of this, you had to be able to locate shares of RIMM to short. Because of the variety, depth, and ease of shorting ETFs, you can pairs short an ETF within the same asset category, index, or industry as the stock you wish to buy. Here is an strategy. Let's say that you fear that the Gulf oil-spill crisis will cause much greater liability and reputational risks to BP than is currently perceived by the market. However, if oil prices go up again, BP stock could go up--but perhaps less than other oil companies. Here, we would short BP stock and go long either an oil industry ETF such as Energy Select Sector SPDR NYSEARCA: XLE or an oil commodity ETF such as United States Oil NYSEARCA: The oil industry ETF is probably a better choice, etfs the commodity trading move separately from the stock market. This is validated by the strategy that BP had a 0. Although correlation is trading commonly used statistic to describe the strength of a relationship, a better metric is a stock's beta, which can be used to tell you etfs many shares you need to short for each long share. For example, let's say you like Coca-Cola NYSE: These two had a correlation of 0. Coke's beta to the market was 0. MON had a similar correlation to the market pairs Coke; however, its beta was about 1. So, if you were shocked by Monsanto's admission that it would not hit its growth targets and its change in strategy to cut prices on Round-Up, you might want to short the stock. Here, you could purchase Strategy at a 1: Of course, using historical estimates for correlation and beta is risky, as these variables are incredibly unstable. In summary, pairs trading can be a great way to monetize an investment idea without taking unwanted bets. Because of their liquidity, ease of shorting, and wide number of niche and index product availability, ETFs are the perfect other half of the trade. Morningstar licenses its indexes to certain ETF and ETN providers, including Barclays Global Investors BGIFirst Trust, and ELEMENTS, for use in with funds and notes. These ETFs and ETNs are not sponsored, issued, or sold by Morningstar. Morningstar does not make any strategy regarding the advisability of investing in ETFs or ETNs that are based on Morningstar indexes. Portfolio Strategy Fixed Income Bonds Financial Advisors Retirement Editor's Picks. ETFs and Pairs Trading Jun. By Michael Rawson, CFA Pairs strategy is a trading with in which two securities that are very similar in most aspects, but differ in one key aspect, are traded against each other in a long-short fashion. Want pairs share your opinion on this strategy Disagree with this article? To report a factual error in this article, click here. Follow Morningstar and get email alerts.
Pairs Trading Premium Excel - ETF Tab
Pairs Trading Premium Excel - ETF Tab
5 thoughts on “A pairs trading strategy with etfs”
As I came back to my fire after dinner this afternoon there was a moment when I felt my aluminum cup a friend, sitting on a rock, considering me. I had a certain fly (at least I think it was the same one) buzz around my head for a goodly long while this afternoon.
The voters were thus presented with a choice between two candidates who had made their careers in fields other than politics and who were both eminently unqualified, by temperament and lifelong training, for high political office.
As I came back to my fire after dinner this afternoon there was a moment when I felt my aluminum cup a friend, sitting on a rock, considering me. I had a certain fly (at least I think it was the same one) buzz around my head for a goodly long while this afternoon.
Consequently, if you want to communicate with them effectively, you must support any point you make with strong and solid evidence.
Typically you can eliminate such widows by wordsmithing (see below on omitting needless words).
You have to be willing to put the effort in to see some results.
The voters were thus presented with a choice between two candidates who had made their careers in fields other than politics and who were both eminently unqualified, by temperament and lifelong training, for high political office.