2)CONT. FROM LAST POST ...Well we take ex. of Maruti & Tata Motors.both stocks are from one single sector that is automobile.Now we have to short one stock and buy one.We then spend our time on both charts ...here i explain my trade ..on 16th jully As shown in fig.tata motors chart is comparatively weak and maruti's chart is strong
.Now its entirely different subject why this strong and that weak,in short words i will tell,in marutis chart stochastic just bottomed up,rsi nicely made two higher highs and lower lows at bottom at 16th jully,so i brought at 548 on close as it was clearly making doji ,whereas tata motors stochastic and rsi wasnt of my liking(when rsi made big base i never go on long)
.i short the stock tata motor at 16th jully at 406rs.
3)if xample seems bit difficult to understand as i am new to this posting kind of stuff then you jut consider that we are long on maruti and short on tata.
4)So nearly after one month( i will skeep how to role over ur contract with less 'cost of carry' part )you have a position in your hand like this ..
5)as shown in chart at 14 th augst. tata motor is at 450 and maruti at 705rs.u have 50 rs loss( approx.12 to 14 %)on tatas short position and profit on marutis long position150rs(apprx.24 to 26%), so you have nearly 10% profit in hand
6)Now you might ask why such a fuss just add 10 contracts long on maruti n reap off the profit,instead of adding 5 contracts long n 5 short? well as a trader we must accept a fact that we play with the probability.our aim is by any means and tools add the math of probability in our favor.If one is novice in trading his probability of loosing is nearly 100%,then we learn fundamentals,study micro and macro economical factors,learn complex credit reserve ration n so many fundamental things like P.E.,yield,beta n all then we make probability of winning bit higher,then learn technical analysis and made probability of winning bit higher,more sophisticated you become and learn your probability of winning gets higher ,still..still n still we cant make winning probability 100% no one ever done and no one ever could.PAIR STRATEGY GIVES CUSHION TO YOUR PROBABILITY .
7)suppose overnight you learned R.B.I.hiked the interest rate by 50bps then next day all interest rate sensitives tumble,including our very own automobile sector,then our short position in tata motors gives us cushion to our loss making maruti long position.as tata motor is weak in sector will fall more than strong maruti
8)And suppose in overnight rbi slash interest rates then there will be rally in auto sector n maruti long gives cushion to tata short.
9)Also many times stocks fluctuate in tendom with market we say it beta,so we minimize that fluctuation. In other way we can say grossly we holding very low beta stock so ur risk or probability of wiped out is less
other examples of pair trading -
.now u can see hedge funds operate somewhat same way,they long on s&p500 and dowjones and short on nifty since 6 month...also you can short RIL and buy crude oil future..so many examples
