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High-Risk, High-Return Trading Strategy : Pair Trading

Learn2Trade Series: Episode 41

Find out how to trade with Mr. Vivek Bajaj. Most traders anticipate the stock market will provide a high return, but high returns are directly correlated with increased risk. In this video, he will talk about a high risk reward trading strategy: pair trading. Pair trading involves selecting two stocks with comparable business models and taking a long or short position following their correlation. He will quickly review each of the eight trading strategies in the opening minutes of this video. The most crucial aspect of pair trading is determining which pairs to trade. He will provide instruction on spotting these pairs using StockEdge and the two varieties of pair trading.

What You Will Learn

Mr. Bajaj begins the session with a summary of the 40 prior sessions, emphasizing the range of topics discussed, including concepts of relative strength, options trading, trading strategies, and the fundamentals of technical analysis. He then introduces the upcoming focus on pair trading, acknowledging its complexity and suggesting that viewers understand the basics, even if they may not immediately engage in pair trading.

An overview of several trading methods is given at the beginning of the discussion, including spread trading, multi-asset trading, options strategies, pair trading strategy, technical strategy, arbitration, and jobbing/scaling. Mr. Bajaj stresses the significance of moving from simple to more complicated strategies gradually, according to the comfort and skill level of the viewer.

In order to profit from the relative performance of the two assets, pair trading involves simultaneously taking a position in one and a counter position in another. There are two main methods of pair trading that are covered: Statistical Pair Trading and Relative Strength Pair Trading.

Statistical Pair Trading includes choosing instruments that have a historical relationship, with the expectation that if one deviates significantly from its mean, it will eventually revert. He uses the example of ICICI Bank and HDFC Bank to demonstrate this. He highlights the possible benefit of using pair trading to offset market risk.

On the other hand, Relative Strength Pair Trading emphasizes the instruments' current strength. If one instrument outperforms the other, the trader goes long on the strong instrument and short on the weak. Vivek Bajaj uses the two companies ITC and HUL (Hindustan Unilever) to demonstrate this strategy.

He suggests using platforms like TradingView, which allow users to create watchlists of pairings, analyze past performance, and identify potential opportunities in order to execute this high risk reward trading strategy - pair trading. He explains the concept of creating a ratio chart for a pair, emphasizing the importance of knowing the relationship between the two instruments.

The session delves deeper into the use of technical indicators, notably the Super Trend indicator, to determine entry and exit points for pair trading. He provides examples of how traders can use the Super Trend to determine the direction of the pair's trend and make well-informed decisions.

The practical components of pair trading are also covered, such as how to use options to reduce capital requirements and manage risk. He provides advice on how to choose options depending on expected volatility, market circumstances, and premium prices.

While Mr. Bajaj acknowledges that pair trading is an intricate approach that requires careful study, he advises viewers to understand the core ideas, perform more research, and practice with actual data. He emphasizes the need to know the business models of the paired instruments and recommends analyzing co-relationships to identify appropriate pairings.

He highlights in his conclusion that pair trading strategy is a complex and intricate trading strategy. He advises viewers to delve deeply into the subject, make the most of the tools at their disposal, and progressively add pair trading to their toolkits as they develop confidence and expertise in the volatile world of trading.

Frequently Asked Questions (FAQs)

Q1. What is the difference between pair trading and other trading strategies?

Taking a position in one stock and a counterposition in another at the same time, based on their correlation, is known as pair trading. In contrast to other techniques, it concentrates on the relative performance of two assets instead of the movements of one individual stock.

Q2. What aspects need to be taken into account when selecting options for pair trading, and can pair trading be executed using them?

Yes, options may be used to do pair trading. When selecting options to manage capital requirements and risk, traders should take into account variables including predicted volatility, market conditions, and premium pricing.

About Mr. Vivek Bajaj

Vivek bajaj image

The passion for data, analytics and technology is what makes Vivek Bajaj a financial market survivor. The journey as a market participant started in 2002 when the first trade was executed in the options contract of ITC. Life was simpler and easier during that time. Since then technology and Big data have taken over totally. As an early adapter to the complex tools, Kredent was formed to capitalise on the opportunities. He is co-founder of StockEdge and is committed to bring simplicity in the complex world of market data. He is a Chartered Accountant, Company Secretary and an MBA from IIM Indore. He is a part of various committees of exchanges and regulator and he has been an active contributor in the evolution of Indian Derivatives Market.

Learn2Trade Series: Episode 41

Find out how to trade with Mr. Vivek Bajaj. Most traders anticipate the stock market will provide a high return, but high returns are directly correlated with increased risk. In this video, he will talk about a high risk reward trading strategy: pair trading. Pair trading involves selecting two stocks with comparable business models and taking a long or short position following their correlation. He will quickly review each of the eight trading strategies in the opening minutes of this video. The most crucial aspect of pair trading is determining which pairs to trade. He will provide instruction on spotting these pairs using StockEdge and the two varieties of pair trading.

What You Will Learn

Mr. Bajaj begins the session with a summary of the 40 prior sessions, emphasizing the range of topics discussed, including concepts of relative strength, options trading, trading strategies, and the fundamentals of technical analysis. He then introduces the upcoming focus on pair trading, acknowledging its complexity and suggesting that viewers understand the basics, even if they may not immediately engage in pair trading.

An overview of several trading methods is given at the beginning of the discussion, including spread trading, multi-asset trading, options strategies, pair trading strategy, technical strategy, arbitration, and jobbing/scaling. Mr. Bajaj stresses the significance of moving from simple to more complicated strategies gradually, according to the comfort and skill level of the viewer.

In order to profit from the relative performance of the two assets, pair trading involves simultaneously taking a position in one and a counter position in another. There are two main methods of pair trading that are covered: Statistical Pair Trading and Relative Strength Pair Trading.

Statistical Pair Trading includes choosing instruments that have a historical relationship, with the expectation that if one deviates significantly from its mean, it will eventually revert. He uses the example of ICICI Bank and HDFC Bank to demonstrate this. He highlights the possible benefit of using pair trading to offset market risk.

On the other hand, Relative Strength Pair Trading emphasizes the instruments' current strength. If one instrument outperforms the other, the trader goes long on the strong instrument and short on the weak. Vivek Bajaj uses the two companies ITC and HUL (Hindustan Unilever) to demonstrate this strategy.

He suggests using platforms like TradingView, which allow users to create watchlists of pairings, analyze past performance, and identify potential opportunities in order to execute this high risk reward trading strategy - pair trading. He explains the concept of creating a ratio chart for a pair, emphasizing the importance of knowing the relationship between the two instruments.

The session delves deeper into the use of technical indicators, notably the Super Trend indicator, to determine entry and exit points for pair trading. He provides examples of how traders can use the Super Trend to determine the direction of the pair's trend and make well-informed decisions.

The practical components of pair trading are also covered, such as how to use options to reduce capital requirements and manage risk. He provides advice on how to choose options depending on expected volatility, market circumstances, and premium prices.

While Mr. Bajaj acknowledges that pair trading is an intricate approach that requires careful study, he advises viewers to understand the core ideas, perform more research, and practice with actual data. He emphasizes the need to know the business models of the paired instruments and recommends analyzing co-relationships to identify appropriate pairings.

He highlights in his conclusion that pair trading strategy is a complex and intricate trading strategy. He advises viewers to delve deeply into the subject, make the most of the tools at their disposal, and progressively add pair trading to their toolkits as they develop confidence and expertise in the volatile world of trading.

Frequently Asked Questions (FAQs)

Q1. What is the difference between pair trading and other trading strategies?

Taking a position in one stock and a counterposition in another at the same time, based on their correlation, is known as pair trading. In contrast to other techniques, it concentrates on the relative performance of two assets instead of the movements of one individual stock.

Q2. What aspects need to be taken into account when selecting options for pair trading, and can pair trading be executed using them?

Yes, options may be used to do pair trading. When selecting options to manage capital requirements and risk, traders should take into account variables including predicted volatility, market conditions, and premium pricing.

About Mr. Vivek Bajaj

Vivek bajaj image

The passion for data, analytics and technology is what makes Vivek Bajaj a financial market survivor. The journey as a market participant started in 2002 when the first trade was executed in the options contract of ITC. Life was simpler and easier during that time. Since then technology and Big data have taken over totally. As an early adapter to the complex tools, Kredent was formed to capitalise on the opportunities. He is co-founder of StockEdge and is committed to bring simplicity in the complex world of market data. He is a Chartered Accountant, Company Secretary and an MBA from IIM Indore. He is a part of various committees of exchanges and regulator and he has been an active contributor in the evolution of Indian Derivatives Market.

Other series by Elearnmarkets

Through this series, watch Vivek Bajaj simplify investing and key components required to build a habit of investing and unleash the power of compounding.

All Episodes

Other series by Elearnmarkets

Watch Mr. Vivek Bajaj introduce the basic concepts of trading and discuss the various stock market indicators.