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  • nmnmike nmnmike Aug 18, 2014 9:27 AM Flag

    PAIRS TRADE: Long SLV - Short GLD simply explained

    Statistical Arbitrage Trading Easily Explained. Part 1/2

    Many people have extreme difficulty understanding how Statistical Arbitrage trades work but my goal here is to simply explain them and why many industry Professionals use them...

    I started a Pairs Trade campaign in SLV versus GLD - - That means for every 6.5 shares LONG the SLV I went short 1.0 GLD. As a trader I really used Gold and Silver Futures because Margin costs are almost cut in instead of this trade costing $16,000 it only costs $8,000 per unit trade but lets use the SLV & GLD because they will work just fine.

    A "Statistical Arbitrage" trade or "Stat. Arb" and a "Pairs Trade" are all the same thing so there will be no confusion.

    A "Pairs Trade" simply involves TWO HIGHLY CORRELATED trading assets which NORMALLY rise in price together and fall in price together as each and every trading day passes... but occasionally they get OUT OF WHACK from each others NORMAL HIGHLY CORRELATED relationship by such an EXTREMELY LARGE RATIO where one trading asset will become the OUT PERFORMER while the other trading asset becomes the UNDER PERFORMER...when this happens traders will take a PAIRS TRADE betting that over time the two NORMALLY HIGHLY CORRELATED trading assets will REVERT back closer to their NORMAL HIGHLY CORRELATED RATIO'S...this closer to normal ratio is called the "MEAN RATIO" and in this example our Pairs Trade goal is a trade back to "Mean Reversion"...or a "Mean Reversion trade".

    This exact OUT PERFORMER condition exists in Gold or GLD while the UNDER PERFORMER is Silver or SLV" ' making these TWO normally HIGHLY CORRELATED trading assets primed for taking or starting a Statistical Arbitrage / Pairs Trade... betting that eventually - over time - these two trading assets "Mean Revert" back to their normal Highly Correlated status.

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    • PAIRS TRADE: Long SLV - Short GLD simply explained
      Statistical Arbitrage Trading Easily Explained. Part 2/2

      The beauty of a pairs trade like the one being described is that the trader could care less if Gold Or Silver is bullish or bearish because the trader makes money regardless of direction. The traders only goal is to have the GOLD : SILVER ratio relationship come back towards more normal relationships. I started this trade knowing the more Normal Mean Reversion Relationship between Gold & Silver is about 16:1 but these two Precious Metal assets have gotten SO FAR OUT OF WHACK with each other to the tune of over 67:1 Gold Price being the outperforming metal over Silver. since the start of this trade the ratio has SLOWLY started to Mean revert about 66.5:1 a very meager profit. The idea is to bank some of those profits along the way to preserve them while reducing risk. This type of trade usually takes time and sometimes needs adjustments which is why patience is required for the larger expected gains...However if the trade goes against the trader in a large way he does not panic...As a professional trader you either take the gauged loss or add more position size because past statistics going back almost 40 years tell you the odds are in your favor....kind of what like Bill Ackman has done with HLF against Carl Icahn.

      Sincerely hope this helps some trader willing to learn how to become a better trader!

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