Two Good Trades

Trading isn’t rocket science.  You don’t need to be a market savant or mathematical genius in order to succeed.  You must be patient, seize opportunity, and stick to what you know.

Your “opportunity” depends on what you trade.  It’s different for everyone.  The critical point is to know the difference between an average opportunity and a great opportunity and vary your bet accordingly.  There is no sacred or magical mathematical computation or holy indicator setting.  Just know yourself, and study what true opportunity looks like.  Then, back-test your ideas to make sure you’re on target.  One of the great things about trading spreads is that you’ll see things in the chart that no one else is watching.  When you transform flat price action into a spread chart you alter your perception and see many new trading opportunities.

When reviewing the activity in my core pairs trading strategy I came to the conclusion that my best trades fall into one of the following two types.

Trade Number One: Large bracketing range spread with fundamental edge.

Key characteristics of this trade: large, correlated, liquid instruments; a consistent range; and structural, fundamental, or event driven catalysts in your favor.   I use the predictability of the relationship as a backdrop to trade them back to their mean.

Here’s an example:

Trade Number Two: Game-change range breakout.

Key characteristics of this trade: spread breaks an long established range in an aggressive manner, and the breakout is precipitated by a major catalyst such as earnings.   In this case I assume that the spread will seek out price discovery in the short term before resuming a mean reverting property in the long term.  I will short the spread on the first major pullback and exit just below the prior low (see red arrow).  The change in time horizon allows me to trade against some of the longer term probabilities to exploit an opportunity.  Here’s an example:

The problem with the type-two trade is there’s a chance you’ll already be in the trade, taking major pain if you entered it as a type-one.  Hopefully you take the advice and trade spreads small or not at all around earnings.  Statistics and historical relationships go out the window when there’s a catalyst.  If you get stuck in a trade with new information you must destroy the old idea/trade and embrace the new opportunity.  It’s part of making the sausage.

These are the trades I will focus the most attention and capital on in the future.  The rest are just noise.  Find your two good trades.

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