Spread Betting and Pairs Trading
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When it comes to spread betting strategies many traders today opt for pairs trading.
Pairs Trading Concept:
Pairs Trading Concept: To make a net profit from two opposite spread betting positions on a pair of related stocks.
Spread Betting - Pairs Trading Example
Imagine that a spread bettor specialises in the financial sector. To engage in pairs trading, that spread bettor would need to find two stocks with a correlation; a strong tendency to move in line with each other on a day-to-day basis. For the purposes of the example, let’s say that Bank X and Bank Y represent a relationship like this and are therefore a suitable pair.
Next, the spread bettor needs to decide if one of the two stocks is under- or overvalued in comparison to the other. If the trader believed that Bank X was undervalued relative to Bank Y, they would go long (open a 'buying' position) on Bank X whilst simultaneously going short (taking an equivalent 'selling' position) on Bank Y.
These two opposing financial spread bets need be worth roughly the same amount, for example Bank X: 300 price x £8 stake = £2400, Bank Y: 1200 price x £2 stake = £2400. The reason for this is that if they are not, then the spread bettor is merely reducing the risk of the larger trade rather than creating a situation in which they can profit from the pair regardless of whether the overall markets move higher or lower.
If the overall market was now to move upwards, the Bank X spread bet, the undervalued stock, would in theory close the gap and enter a profit greater than the loss incurred by the 'short' Bank Y spread bet.
Similarly, if the market was to dip, Bank X's stock would presumably not dip as far as Bank Y's stock, therefore putting the Bank Y spread bet into a profit that outweighed the Bank X loss.
In this respect, pairs trading is similar to hedging in financial spread betting, as it can create an equilibrium where one half of the pair becomes profitable when the other half loses money.
Spread Betting – Forex Pairs Trading
It also follows the same principle as Forex spread trading, where every spread bet you make is actually two spread bets. For example, in the case of a £/$ trade, one bet would go long on Sterling whilst one would go short on the Dollar.
Strategies and Pairs Trading
One good way to get to know pairs trading is by using a spread betting demo account with a firm like City Index to place a range of spread bets without risking your own money.
As with all spread betting strategies, the overall goal of pairs trading is to make profits that exceed your losses. If you can find a spread betting strategy that does that for your trading, the only thing that you need to do is stick to it.
Spread betting and CFD trading are leveraged products which can result in losses greater than your initial deposit. Ensure you fully understand the risks.
City Index Account / Website |
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Risk Warning: Spread betting, CFDs and Forex trading are leveraged products which can result in losses greater than your initial deposit. Ensure you fully understand the risks.
'Spread Betting and Pairs Trading' edited by DB, updated 20-May-13
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