http://www.guerillastocktrading.com/stock-trading/pair-trading-apple-appl-and-research-in-motion-rimm I have got oodles of interest on my pair trading article and the play I entered in both Apple and Research In Motion. I went long Apple and short Research In Motion.

The approach of matching a long position with a short position in two stocks of the same sector is called pair trading. This forms a hedge against the sector and the general market that the two stocks are in. The hedge created is essentially a gamble that you are placing on the two stocks; the stock you are long in against the stock you are short in.

As its name suggests, a pair trading line of attack is a double-pronged method, where two apparently unrelated option or stock positions are opened simultaneously. The tactic can give somewhat of a safety net to defend against an unexpected move in a certain sector, while capitalizing on a specific equity’s relative-strength backdrop.

In effect, a pair trader hedges his or her bets, opening positions in two interrelated equities or indexes and working them against one another, choosing 1 call (bullish) position and 1 put (bearish) position. The duo of positions then collectively gives money-making returns amid a number of outcomes.

For instance, I had a great point of view regarding Apple, but a pessimistic sentiment concerning Research In Motion. I went long on Apple whereas I shorted Research In Motion.

I also had an uneasy sentiment concerning the entire technology sector. By taking a short position in Research In Motion, it permitted me to profit if a large sell off in technology happened. This profit on the short side would offset my losses in Apple on the long side.

Apple maintained its relative strength versus Research In Motion. The shares rallied and the short side of the trade (Research In Motion) fell. Both sides of the paired trade enter positive territory.

However let us say the whole tech sector suffers a broad decline. The Research In Motion short is profitable, counter-acting the Apple long position which nets a loss. This is a better outcome than if I merely went long on Apple.

You’re looking for the percentage change in the market between Apple and Research In Motion to move in Apple’s favor no matter which direction Apple or Research In Motion go.

On May 14, 2009, I went long Apple at 122, and short Research In Motion at 71. I closed out the pair on July 10th 2009 with Apple at 137 and Research In Motion at 66. I made 12% on my Apple long, and 7% on my Research In Motion short. So the total gain was 19%.

Duration : 0:2:48

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