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Old 03-01-2013, 12:02 PM   Nav to Top  #1
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Default Pairs trading strategy

One question I receive occasionally is whether or not the LRC Channel works on other indexes, stocks, currencies, etc. My back testing shows that contrarian credit spreads are best traded on low beta – broad based indexes.

The next best results are in bond instruments (TLT) and broad based ETFs (XLK, XLY, XLF, etc). Individual stocks are generally inconsistent when it comes to mean reversion. This doesn’t mean that taking the opposite position will work either… it means sometimes they will perform great and other times they will take off and not offer a profitable mean reversion opportunities for months if not years.

There is one aspect of individual names that does offer an opportunity for mean reversion that I have yet to fully test (but I am working on it). This is the opportunity of pairs trading. In TOS you can view a pairs chart simply by typing a symbol minus another symbol (examples: QQQ-IWM, GM-F). When you look at separate charts of GM and F, you will see individual stocks that experience periods of rapid price change and periods of choppiness. When you look at the chart of the pair (GM-F), you see something that appears to be choppy and mean reverting most of the time. Enter pairs trading with LRC Channel credit spreads...

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F, gm, iwm, qqq, XLF, xlk, xly

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