Pairs trading is like having a safety net in the roller coaster world of stock trading. It helps balance out risks and boosts chances of making money. Let's dive into why pairs trading makes sense, using Marico and ITC as an example. But first, let’s talk about the risks and how this strategy can still be a winner.
The Risks of Pairs Trading
Market Surprises: Imagine you're at a calm beach, and suddenly a huge wave comes out of nowhere. Unexpected news or events can disrupt the balance between two stocks, causing them to move unpredictably.
Execution Challenges: It's like trying to catch a bus at the exact right moment. If you're too slow or too fast, you might miss it or pay more to get on.
Liquidity Problems: Think of it as wanting to buy a rare toy. If not many are available, you might have to pay a higher price, or you might not get it at all.
Model Errors: Sometimes, your math can be off. If your strategy is based on wrong assumptions, it might lead you astray.
Worst-Case Scenarios
Even with these risks, pairs trading is like having an umbrella on a rainy day—it's better than getting soaked. Here’s what can go wrong and why the strategy is still solid:
Both Stocks Move Against You: If both stocks don’t go your way, you can lose money. But because you're betting on one stock going up and the other down, you’re not as exposed to big market swings.
One Stock Takes Off: If one stock skyrockets while the other stays put, it can hurt your trade. But usually, this is rare because the stocks are linked.
Stocks Break Up: If the stocks suddenly stop following each other, your strategy might not work. But by keeping an eye on them, you can adjust and avoid big losses.
Why Pairs Trading Remains Profitable
Pairs trading is smart because you’re betting on both sides of the market. You buy one stock (long) and sell another (short), balancing out the risks. Plus, because you’re hedged, you don’t need as much margin, meaning you can trade more with less money.
Example: Marico and ITC
Let's see how pairs trading works with Marico and ITC. This strategy has shown great results over the past four years. Here’s a quick look at the numbers:
Metric | Value |
Average Profit per Profitable Trade | INR 41923 |
Average Loss per Losing Trade | INR 17315 |
Total Trades | 33 |
Trades Expired in Profit (assuming 15 days holding period) | 13 |
Trades Expired in Loss (assuming 15 days holding period) | 8 |
Total Profitable Trades | 21 |
Total Losing Trades | 12 |
Let's also look at how the capital has increased in this strategy:
Performance Analysis
Profitability: Out of 33 trades, 21 made money. That’s a win rate of about 64%.
Trade Duration: Holding each trade for about 15 days means you’re in and out quickly, reducing risk.
Average Returns: Profits average INR 41,923 per trade, while losses average INR 17,315. You’re making more on your winners than you’re losing on your losers.
Total Capital Increase: Over four years, you’d have made INR 276,230, showing the strategy’s long-term success.
How Our Pairs Trading Tool Works
Our tool makes pairs trading easy and fun. Here’s how it works:
Input Two Stocks: Enter the two stocks you want to trade.
Cointegration Check: The tool checks if the stocks move together over time.
Backtesting: It then shows you how the strategy would have performed over the past four years.
Trading Signals: Finally, it tells you if you should open a position based on current market conditions.
Conclusion
Pairs trading is a great way to make money while balancing risks. The example of Marico and ITC shows how profitable this strategy can be, with a strong average profit per trade and a significant capital increase over four years. Our pairs trading tool helps you find the best pairs, backtest your strategies, and make smart trading decisions. Even with the risks, pairs trading can help you achieve your financial goals and enjoy the roller coaster ride of the stock market.
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