Today I want to publish a pair trading idea.
The thing is that the spread between DDM and IWO reached the upper border. You can see the red line on the bottom chart. Basically, this value has not been broken since 2007. Even in 2008 and 2009 when the was huge.
Saying so, we can assume that the spread is going to be zerro in the nearest future.
Thus, we should "short" DDM and take "long" IWO.
Well, I can explain the math basis of the trade if someone is interested in it.
The major thing we should look at is the position of the spread. If it is > 0 than we should short upper stock and long the second one. If it is < 0 than we should long the main stock (upper one) and short the second one.
I use a number of factors in the strategy: correlation, cointegration, std devs moving averages, levels and upcoming fundamental events/news.
As for risk management and position size:
- we should use equal sums for both stocks. For instance, we want to use 10 000$ per trade. It means that we should open short "DDM" position for 5 000 and long "IWO" position for 5 000
- do not use the whole capital per trade. I do not recommend you to use more than 30% of you portfolio per one such trade.
- stop loss: I recommend to close position if the spread will reach 0.1 or you can just double your current position. If you use about 15% per trade this would be the best solution
- target: when the spread will be around zerro we should close our position
- timing: normally, we hold such positions for 3 weeks - 2 months
- profits are not big but the risks are pretty low and if you have about 15 pairs in your portoflio the strategy is pretty good
- risks: not more than 10% that we will reach stop loss. Sometimes, even if the spread turns zerro we can see losses, however, they pretty small. Nor more than 0.25% per portfolio (with moderate position sizing)
Here's the spread code. If you want to use it for other instruments you just should change ticker names in the code ( DDM and IWO)
study("Spread", shorttitle="SpreadRatio", overlay = false)
s = security("DDM", "D", close)
s1 = security("IWO", "D", close)
ratio = s/s1
maratio = (ratio, 50)
spreadratio = ratio - maratio
Thanks for your attention and good luck!