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ShadowTraderPro Pairs Trader for September 10, 2009
The ShadowTraderPro Pairs Trader is a daily report which spotlights one equity pair which trades in a definable range and whose stocks are positively correlated. The objective of the newsletter is to present one such pair daily that may be coming into play currently, giving self-directed traders the opportunity to put the pair on watch for possible entry. Additionally, Pairs Trader sends out specific trade recommendations on selected equity pairs. These trades are managed actively via real-time email alerts and are tracked in the Pairs Trader Portfolio. To get the most out of your subscription, please read our Pairs Trader User's Guide If you have any questions or comments regarding commentary or plays in this newsletter, please email to pairstrader@shadowtrader.net. Pair of the Day
 So, let's talk about the GLD-GDX trade which may have scared the pants off of some traders but turned out fine with a break-even exit yesterday. Some major things happened in this pair which should have been very educational for those of you who are trying to learn to think for yourselves. Let's recap: 1. When there is a huge difference between the betas of the two stocks in the pair, you must either beta weight them or possibly even pass on the pair. In our case we disregarded this and dollar weighted the pair and it caused us to take much more heat than was necessary in the pair. The beta of GDX is 10 times the beta of GLD. Now due to the fact that one of the stocks is a mining ETF and the other one is Gold itself, the betas (which are measured against the S&P 500) should just be a starting point. There is also the question of how the stocks react in relation to each other since the price of gold is extremely correlated to the price of mining shares. In general you always get more bang for your buck percentage-wise from mining shares rather than the gold ETF. When dollar weighting puts too much size into the higher beta issue (GDX), it magnifies profits and losses accordingly. 2. The RSI2 study is a good tool to tell you when a pair may be rebounding. Although this pair briefly traded below our original stop point, we did not exit in a panic for a large loss. One of the reasons was the use of the "fast" RSI. Note how in the circled area in the chart above, there is clear touch of the lower range in the 5 area. This is indicative of extreme oversold conditions in the pair and would definitely not be the area to exit. 3. Know what type of pair you are in. ie: is it trending or not? Please compare this trade with the PRU-MET trade taken in August. That was our only real losing trade since beginning the advisory. Although we were selling a resistance point, the pair was clearly trending and thus there was bias for PRU to stay stronger than MET. GLD-GDX has large spikes in either direction but is clearly not a trending pair. 4.Which brings us to our last point. When the pair is against you a good clip due to some manner of miscalculation or other and it briefly trades back to your break-even point, get out. Remember, spread prices can and do change quickly. Take profits when you have them and exit for small losses immediately if you feel that the pair will not produce a profit. Pairs Trader Portfolio To get the most out of your subscription and for detailed instructions on how to structure your own portfolio, read our Pairs Trader User's Guide
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