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  Pair trading explained
  An introduction to option trading with stock pairings

With pair trading investors bet on one share out of a stock pairing outperforming the other. This bet is entirely legitimate as it is based on a background of economic activity. Commonly pairings are traded that are in a meaningful relationship with each other, mostly as representative of their sector. Thus it is naturally worth betting if Microsoft shares will rise faster than those of Apple or how the rate of Daimler shares will develop compared to BMW’s. Pair trading is especially exciting if the shares – when the sector had been experiencing a boom – have in the past developed quite similarly. The binary option broker Stockpair offers pair trading with binary options, this trading tool is already indicated in the name.

Pfeil grün Pair trading strategy

The advantage of pair trading is that, even when the markets tend to move sideways or to fall, one share still will outperform another. The comparison of two values necessarily always produces a winner and a loser. Of course this speculation is not easy to conduct; traders use as indicator for example the Relative Strength Index (RSI) for shares, which they then compare for both stock values. That way a market neutral difference between the two share values can be predicted. At the Stockpair brokerage investors can find binary options that already include this principle for certain stock pairings; Microsoft versus Apple is a classic among them, but so is Google versus Apple.

Through the design of binary options pair trading becomes very simple, for with classic trading tools one would have to either buy derivatives or even short sell blocks of shares, which requires a special trading account and at times is subject to legal restrictions (during crashes the Fed keeps banning short selling for days, some politicians want to outlaw it completely). The trader needs a tool with which to bet on falling rates as well, in order to make pair trading work. Derivatives and among them binary options traditionally also bet on falling rates via put options. If now a broker within a single binary option allows for performance comparison between two rates, pair trading becomes very simple. That is what Stockpair is concentrating on, they are apparently so far the only among the binary option brokerages offering this instrument.

Pfeil grün Pair trading at Stockpair in practice

Those trading binary options at Stockpair will find, among others, the instrument of pair trading. The broker has designed the strategy here in a very simple manner; the investor selects a stock pairing like Vodafone v. Telekom, Google v. Apple, Microsoft v. Apple, Google v. Yahoo or any other desired pairing, while Stockpair also offers sensible suggestions in this context (theoretically bets can even be placed on the development of the VW stock price against that of the price of sugar, but that would be equivalent to a coin toss). Now the investor decides not if the shares overall will rise or fall but merely which of the two will perform better. As always the broker participates in the bet because the riskier the bet appears from the broker’s viewpoint the higher the return that will be awarded. Investors can view this involvement of the broker in the bet in two ways:

  • You may assume that the broker certainly knows what he is doing. They have the experts after all. Therefore as investor I am well advised to choose a less risky bet (with a somewhat lower return).
  • Investors may also confidently assume that the broker’s experts probably err just as often as other people. Therefore the investor might just choose the bet with the higher return.

You should decide for yourself which type of investor you are.
In any case it is sensible with pair trading to conduct basic research. After the death of Steve Jobs for example some experts expect that Apple’s share price could halve over the next years. This explicitly does not represent an investment recommendation (in regard to falling Apple shares), but it might be used as just one aspect in speculating on a weaker Apple rate vis-à-vis other technology stocks like Google or Microsoft in pair trading.

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