Spread Betting Pairs Trading
An increasing number of traders today opt for pairs trading when deciding their financial spread betting or CFD trading strategy.
The concept centres around balance. Through pairs trading, a trader aims to create overall profit by taking two opposite spread betting positions on a pair of related stocks. Award-winning spread betting provider City Index explains pairs trading with this example:
Spread Betting Pairs Trading: Example
Spread Betting Pairs Trading Step 1: Selection
To engage in pairs trading, a trader first needs to find two shares with a correlation; a strong tendency to move in line with each other on a day-to-day basis. For the purposes of the example, let us say that Bank A and Bank B represent a suitable pair.
Spread Betting Pairs Trading Step 2: Value
Next, the spread bettor needs to decide if one of the two stocks is under- or overvalued compared to the other. If the trader believes Bank A is undervalued compared to Bank B, they will go long (open a 'buying' position) on Bank A whilst simultaneously going short (taking an equivalent 'selling' position) on Bank B.
Spread Betting Pairs Trading Step 3: Trade
These two opposing financial spread bets need be worth roughly the same amount. For example, if your position on Bank A is worth £2400 (300 price x £8 stake), your position on Bank B should be £2400 also (1200 price x £2 stake).
The reason for this is that if the trades are not equal, the trader is merely reducing the risk of the larger trade rather than creating a situation in which they can profit from the pair regardless of whether the overall markets move higher or lower.
Spread Betting Pairs Trading: The Result
If the overall market was now to move upwards, the trade on Bank A (the undervalued stock) would in theory close the gap and enter a profit greater than the loss incurred by the 'short' Bank B trade.
Similarly, if the market was to dip, Bank A's stock would likely not fall as far as Bank B's stock, therefore putting the Bank B trade into a profit that outweighed the Bank A loss.
One way to get to know pairs trading is by using the City Index spread betting demo account to place a range of trades without risking your own money. Finally, whichever trading strategy you ultimately decide upon, always employ risk management including stop loss orders and sound money management.
City Index Account:
Spread betting and CFD trading are leveraged products which can result in losses greater than your initial deposit. Ensure you fully understand the risks. Please seek independent advice if necessary.
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Spread Betting Pairs Trading - edited by MJ, 27 February 2012.
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