In The Handbook of Pairs Trading, Douglas Ehrman covers pairs trading involving stocks, options on stocks, and futures contracts, and explains how this type of trading allows you to profit from the changing price relationship of securities. In addition to a comprehensive discussion of the theories involved, he also includes practical examples that will to help you put what you’ve learned into practice. You will learn both the theory and practice of pairs trading, why it is consistently profitable, and how you can apply the strategies in your own trading with this valuable guide.
Introduction:
This work is divided into five distinct parts. The first four explore the elements that make up the trading of equity pairs and the requisite skills that accompany that endeavor. The final part introduces alternative applications of the theory to alternate security types including options, futures, and currencies. This part also takes the reader step-by-step through a series of trade examples across the various asset classes to both highlight the nuances of each and solidify the reader’s understanding of the theory. The discussion of each topic, equities and advanced strategies, is designed to serve a specific purpose and, in a sense, be able to stand alone. Collectively, however, this work should serve the reader as a comprehensive resource for all of the various types of pairs trading.
The first four parts of this book explore pairs trading from a variety of angles, each with the goal of both illustrating the general tenets of the strategy and presenting one particular approach that the author believes to be superior to others. Toward that end, each section consists of two approaches. The first outlines the general principles that govern the strategy; this will allow those readers who wish to develop their own systems to apply the concepts as appropriate to their ultimate end.
The second provides specific instructions about how to trade pairs of equities following the guidelines that the author believes are critical to portfolio optimization. It is important to acknowledge that no two traders will ever agree fully on the best way to manage a portfolio, and no one is suggesting that the methods favored in this book are final or foolproof words on the subject. What can be said with confidence is that when readers come to the end of these pages, they will not only be familiar with the concepts behind pairs trading but will also have a concrete approach from which to build their individual methodology.
The final part of this book explores the application of the Unified Pairs Trading Theory to alternate asset classes and securities types. While pairs trading is easiest to understand when considering equities, the addition of options, futures, and currencies gives a trader an expanded collection of tools by which to manage his portfolio. Readers are again cautioned to keep in mind that this book is not attempting to be a comprehensive tool for understanding option theory, futures trading or the currency markets. The aim is to set forth simply the building blocks that go into understanding pairs trading.
Many sections may be redundant for experienced traders; anyone who understands the underlying topic of discussion may wish to skip ahead and focus on only the second part of each section where specific theory and application are discussed. Others may feel that too much of a knowledge base is assumed on the part of the author as they approach pairs trading. These readers are urged to explore other sources of reference to expand their understanding of the underlying subject matter. The goal here, again, is to find a middle ground that will prevent the beginner from getting lost and the experienced trader from becoming bored. As this investigation proceeds, each concept builds upon the last with the assumption that the preceding principles have been well understood. It is assumed that the reader has a working understanding of equity pairs trading as each new security type is introduced.
Contents:
- Pairs Trading: A Brief History
- Market Neutrality
- The Market-Neutral Investment Process
- Market Neutrality and Pairs Trading
- Arbitrage Factors
- Arbitrage and Pairs Trading
- Technical Tools and Indicators
- The Technicals of Pairs Trading
- Reviewing the Elements
- Trading Pairs Fundamentally
- The Technical Approach
- The Overlays
- The Unified Pairs Trading Theory
- Options Basics: Terms and Strategies
- Pairs Trading with Options
- Futures and Currencies
- Trade Examples