When people think about putting money in stocks, they tend to think about the direction in which the market is moving. If the Dow, S&P, and NASDAQ are climbing, they feel more inclined to buy shares. If the market is struggling, they’re tempted to rush for the exits. But what if you could make a profit by trading one stock against another stock, regardless of how the overall market is doing? That’s the idea behind stock pair betting, or stock pairs trading. Experienced traders have been using the approach for years to hedge their investments and generate low-risk gains.
Stock pair betting gives you an easy way to trade stocks without being concerned about the performance of the broader market. It provides a simple-to-use system for making profitable trades throughout the year. The market can move up, down, or sideways, and it won’t matter a bit.
We’ll explain how stock pairs trading works below. You’ll learn how to trade one stock against another stock, and where to find a legitimate stock pair betting broker you can rely on. Along the way, we’ll offer a few tips for squeezing as much profit from your trades as possible.
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Stock Pair Trading In A Nutshell
Stock pair betting is an investment strategy that focuses on how two stocks perform against each other. It is based on the notion that the stocks of companies in the same industry can be expected to move in the same direction over time. When one goes up, the other is likely to do the same. When one goes down, the other eventually follows.
There will, of course, be divergences in the stock prices of similar companies. But since the stocks tend to move together over the long run, the divergences will eventually disappear. As they do so, the trader profits.
How is profit generated in stock pairs trading? The trader takes two positions. He goes long in one stock, and shorts the other. The hope is that both long and short positions can be closed at a profit. The more likely scenario is that one position will be closed at a loss while the other position will be closed at a gain. As long as the gain is greater than the loss, the trader makes a profit. This page gives you the review you need.
Long And Short Positions In Stock Pair Betting
How does the trader select which stock to take a long position in and which stock to short? One way to do it is to plot the prices for the two stocks on the same graph. (There are free charting programs online that can do this for you. They display the stock prices in terms of their relative performance.) http://www.binarytrading.org/using-charting-software-to-plan-your-trades/ gives information on how to plan your trades
Assuming they are positively correlated, you’ll see them taking dips and experiencing bumps at the same time. There will also be times during which one stock’s performance increasingly lags the other. The larger the divergence, the sweeter the bet becomes since you can expect their performances to eventually converge.
Take a long position in the stock that is lagging, and short the other one. As their prices move back in line with each other, both your long and short positions will close at a gain.
To be sure, not all stock pair trades work as cleanly as we have just described. Sometimes, the lagging stock continues to underperform. Other times, the stronger stock will continue to climb, leaving the laggard in the dust. Both scenarios are likely to close at a loss. But over time, the stocks of companies that cater to the same market will eventually move in unison.
How To Trade Stocks Against Each Other: Step-By-Step
Let’s summarize the steps for making a stock pair bet.
- First, you need to select two companies that are in the same industry whose stocks tend to move in the same direction. Examples include Coke and Pepsi, Wells Fargo and Bank of America, Home Depot and Lowe’s, and Exxon and Mobil. In the following section, we’ll use an example in which we trade Facebook vs Google.
- The second step is to plot the price ratio between the two companies’ stocks on a single chart. Twelve months is a reasonable period to use since it should capture the ups and downs each company experiences. As noted earlier, there are free tools available online that will generate this type of chart quickly for you.
- Third, select the company you believe will outperform the other. Given the correlation between the two companies, this will normally be the stock that is lagging in relative performance. In a traditional stock pair trade, you would take a long position in that stock and short the other one.
At brokers like StockPair.com, you can skip some of the work we’ve just described. Placing a stock pair trade is as simple as choosing an expiration and predicting which stock will outperform the other. Having said that, it’s important to understand how prices of similar companies move in line with each other, and why divergences in those prices open up opportunities to make a profit. That way, you’re making informed decisions rather than merely guessing.
Trade Facebook vs Google For Market Neutral Profits
In this section, we’ll take you through a hypothetical stock pair bet in which we’ll trade Facebook vs Google. You’ll learn what is involved with executing this type of trade at places like StockPair.com. You’ll also notice why it’s helpful to understand the underlying analysis that goes into picking winners.
- The first step is to visit StockPair to make sure they offer the trade (they do). In the trading section of the site, click “Pairs.” You’ll see the Facebook / Google trade near the top of the list on the left side.
- Second, select between a “fixed” and “floating” pair trade. A fixed pair option has a predefined expiration. The performance of the two stocks is measured from the moment the trade has been executed. A floating pair option can be closed at any time before it expires. The stocks’ relative performance is measured from the beginning of the specified period (e.g. week, month, etc.).
- The third step is to choose the expiration for the trade. You can select 5 minutes, 150 days, or something in between.
- Fourth, pick whether you think Facebook or Google will perform best while the trade is active. You’ll see the potential return you can expect to receive underneath both companies’ names.
The fifth and last step is to choose the amount of money you’re willing to place on the trade and click the “Buy” button. At that point, your stock pair bet is active. You’ll be able to monitor the relative performance of Facebook vs Google in real time at StockPair.com.
Notice how easy it is to simply guess which company will outperform the other? That’s a dangerous way to approach stock pair betting. You’re essentially leaving it up to a flip of a coin. A much better approach is to chart the price ratio between the two companies over the preceding twelve months, and look for divergences. This will give you valuable insight into potential winners.
How To Profit Trading One Stock Against Another Stock
Whether you’re planning to trade Google vs Facebook, eBay vs Amazon, or any other two companies, it’s important to have a system in place. For example, a lot of traders select two companies in the same industry, and then use fundamental analysis (earnings, P/E ratios, etc.) to identify which one looks better from a traditional valuation standpoint. They’ll then use technical analysis to chart the companies’ relative strength and look for gaps (divergences) in their performance. The gaps highlight profit opportunities.
Other traders use support and resistance lines to determine when to execute stock pair bets. They identify the lines and then watch for one of the stocks in a pair to reach them. If one stock hits the resistance line, but the other stock does not, the latter stock is likely to outperform the former. Conversely, if one stock hits the support line, but the other stock does not, the former is likely to outperform the latter.
The main thing to keep in mind with stock pair betting is that it pays to examine the companies you’re pitting against each other. If you plan to trade Facebook vs Google, plot the price ratio between the two companies’ stocks. Look for areas in which the prices move away from each other. Be patient and wait for the right time to get in.
The research is simple. And with the help of stock charting software, it takes very little time. The upside is that the information will help you to identify opportunities to make a healthy profit on your trades.
If you’re looking for a place to get started, we recommend that you visit StockPair.com. It’s a no-nonsense, dependable broker that provides a great training ground to get some experience.