Pair trading on SaxoTrader


Watch the video to see an introduction to the advantages of pair trading tool and how you can take advantage of the opportunities it offers in the SaxoTrader.
More details on CFDs.

Vide​o script​

DEFINITION OF PAIR TRADING

So what is a “pairs trade”? It consists simply of identifying 2 shares that are normally highly correlated, but where the correlation has temporarily broken down. 

To put it simply, you can say that one share has become undervalued compared to another, and this represents an opportunity that you can profit from by trading both a long position and a short position in the two stocks. Since we are looking for stocks that are highly correlated, normally it is a good idea to look at stocks from the same sector or industry, and since you need to be both long and short, you need to trade CFDs when you do pairs trading – a typical example could be Apple and Microsoft, as you see here in the position list.​

METHODOLOGY OF PAIR TRADING​

The first step when pair trading is to evaluate current pair trading opportunities and select the one that you want to execute. Saxo Bank makes this process easy by producing the daily Saxo Equity Pairs trading screener, which you can find on www.tradingfloor.com, under Equities in the Quant corner. On a daily basis you will find up to 10 pair trade candidates on the list, chosen by Saxo Bank’s quantitative analysts through an advanced screening process . You can read the detailed description of the report on the second page where the data is explained. 

So let’s go back to SaxoTrader and have a look at how we can analyze further and then execute the first pair trade on the list, which is simply long American Express and short Legg Mason Inc

If you are interested in technical analysis, you can look at the two shares in the chart, and use the Comparative Studies to deepen the analysis – here, just as an example, I am adding the Correlation study looking 60 days back- This helps us visually confirm that the 2 shares are indeed highly correlated. Other useful comparative studies available are ratio, spread and the Z-score. 

Now let’s have a look at the practical steps in executing a pairs trade:
 
You want to buy 100.000 USD of American Express, and sell 100.000 USD of Legg Mason Inc., so now you open 2 trade tickets side by side, select the 2 shares, select market orders, and make sure to buy American Express and sell Legg Mason incorporated. As a double check you also ensure that the nominal value of the trades are the same before executing the 2 trades

Now you can look at the positions in your open positions module. If you have several positions in your portfolio, to keep better track of your pair trades, you can put the American Express and Legg Mason Inc. positions into a group that you name for example „Pair trade”. In this way, you have the profit and loss number of the 2 positions close to eachother, and as the trade unfolds you can easily see if the strategy is profitable or if it is producing a loss. ​

BENEFITS​ ​OF PAIR TRADING

So what are the benefits of pair trading, and why is it such a popular way of approaching the markets? ​

The primary reason is that it allows you to have a tightly controlled risk – since you are both long and short of shares that are highly correlated, you can profit regardless of direction of the overall market, and you are not exposed if the entire market collapses – as long as both the shares in your trade fall together with the rest of the market. 

So this is a good thing to remember: when you do pairs trading it is normal that you profit on one position while losing on the other – this will typically happen if the entire market moves up or down – still, your pair trading strategy will be profitable, as long as you earn more on your profitable trade than you loose on the other one.

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