Listen up Pair Traders. Are you tired of entering a great looking pair trade only to have the Ratio diverge even further the next day or few days? As this then drags the moving average of the Ratio down with it, not only are you nursing a big loss, but even profits from a recovery may be small or non-existent. If only there was a way to time your entry over a few days by scaling-in to pair trades?
Look no further! Our video below shows you how PairTrade Finder® Ultimate Alpha 3.0 effortlessly calculates and signals scaled-in entries for you, and can even autotrade them straight into Interactive Brokers’ Trader Workstation®:
Does Scaling-In to Pair Trades Sound Too Good to Be True?
Like every trade management technique, scaling-in comes with trade-offs. We use it to optimise our Reward/Risk ratio, protect our trading capital and to try and mitigate the large losses that occasionally occur in single stock pair trading. The idea being to increase CAGR vs. Max DD. So what are the pros and cons?
The PROs of Scaling-In to Pair Trades
- Risk Management: By entering a trade in layers, you mitigate the risk of market volatility and decrease the potential maximum drawdown.
- Increased Profitability: Scaling-in can improve the entry price average, enhancing the potential for profit.
- Flexibility: This approach allows for adjustments based on real-time market analysis and means you don´t have all your eggs in one entry so to speak…
- Increased Universe of Pair Trading Opportunities: When back-testing using a layers approach, many pairs that do not meet Reward/Risk filtering parameters on a single-entry basis will now become attractive to trade on a layered basis (see our video above for an example).
- Psychological Factors: Provides psychological support when a trade goes against you e.g. “good thing I only layered in half” and “Wow this spread really has gone way too far now, maybe I take a second layer at this much much better entry point and come out with a winner?” However, see below…
The CONs of Scaling-In to Pair Trades
- Complexity: Managing multiple entry points requires more sophisticated monitoring and strategy. That is where the beauty of PairTrade Finder® Ultimate Alpha 3.0 comes in – our award-winning pair trading software will do all the calculation and manage the entries and exits for you.
- Costs: More trades can mean more transaction fees, impacting overall profitability. However, if you are using a very low cost broker like Interactive Brokers with a very small fixed transaction fee (as low as $0.50 per trade), commissions and slippage should be manageable. We target less than 10% of Gross Profits
- Undersized Positions: If many trades only trigger the first layer and never the second or third, your trades will be at a smaller R vs. account equity than planned, and hence your overall return on equity will fall short of target. Your Reward/Risk may be superior however.
- Risk Management: Scaling-In can provide the temptation to add further layers to both an offside and onside trade. Once you have reached your target R vs. account equity, no further layering in should occur. Resist the temptation, risk management is there to keep you in the game and consistently profitable.
- Psychological Factors: The technique requires discipline and emotional control to avoid common pitfalls like overtrading and over-sizing and destroying your risk management (see above). “Wow this spread really has gone way too far now, maybe I take a third layer (even though it’s not in my trading plan) at this much much better entry point and come out with my biggest winner of the year?” Sound familiar? A great way to hasten your exit from the trading business. DON´T.
Closing Thoughts
The strategic trading insight of scaling-in to pair trades is just a glimpse of what you learn in our comprehensive online Video Training Course included with your free trial of PairTrade Finder® Ultimate Alpha 3.0.
For those eager to refine their pair trading skills with all of the features our pair trading software has to offer, this layers strategy can be your stepping stone to more robust trading results.
Final Takeaway
Join us to expand your trading toolkit and turn every potential pair into an opportunity for growth. Remember, in trading, knowledge is not just power – it’s profit.
Happy trading!
Geoff, Paul & The PairTrade Finder® Tribe
