Day Trading
The current volatility in global markets has seen large fund out flows away from direct equities into fixed income and cash.
Talk of a “double dip” recession in the US, America losing its AAA credit rating, European leaders trying to salvage Greece from default and global central banks intervening in the currency markets, are all leading to the current global uncertainty.
Who would have thought that on 9 August 2011, the US market fell nearly 600 points and the Australian market closed up the following day?
Who would have thought that with the price of gold rallying to over $1,900/oz, gold stocks would fall in value?
Who would have thought that investors are better off putting their funds in a bank account earning 5.0% interest annually, but are still buying the US ten-year bond rate at a faster pace than prior to the 1940s, with an interest rate of less than 0.50%?
How can you make money in the current volatility with Day Trading?
One strategy that has performed well and continues to perform well in the current market environment, is a strategy known as Pairs Trading (or statistical arbitrage).
The pair day trading is a market neutral trading strategy enabling traders to profit from virtually any market conditions: uptrend, downtrend, or sideways movement.
The pair day trading was first pioneered by Gerry Bamberger and later led by Nunzio Tartaglia’s quantitative group at Morgan Stanley in the 1980s.
When the correlation between the two stocks temporarily weaken (i.e. one stock moves up while the other moves down), the pair trade would be to short the outperforming stock and to take a long position on the underperforming stock, betting that the "spread" between the two would eventually converge (or come together).
Before committing your hard earned money to live Pair Trading there are a number of money management decisions you need to make:
1. What is the minimum capital requirement?
Stock Day Trading should be treated like a business, and most business fail to succeed in their first year mostly due to a lack of capitalisation – day trading is no different. You need realistic expectations about how much capital is required and how the ebbs and flows of trading will impact your account balance. Using leveraged instruments like CFDs for example with a capital investment of $10,000 should be the minimum required.
2. How much leverage and drawdown can you tolerate?
Professional day trading system developers use the data generated from back testing to help ascertain appropriate position sizing levels for trading their system. However, a day trading system is made up of several pairs and the combined trade performance between them. The running profit and loss of your trading system is also determined by the amount of leverage, slippage, and transaction cost applied.
Using a software application like Market System Analyzer you can simulate different money management strategies to determine critical performance statistics like: Maximum system draw down, maximum number of consecutive losses, average return on investment by week and many more. Armed with this information you should have a very good idea about how much leverage to apply to your Pair Trading system, and what maximum draw down (loss) to expect.