There is a trading strategy called Pairs Trading. Here’s how to do it.
Basically you find two stocks that are similar. You want them in the same industry. Ford and GM would be a good example. They are very similar stocks in the same industry.
The strategy is to buy one and sell the other in equal dollar quantities. So you would buy $10,000 of GM and sell short $10,000 of Ford. That way, you don’t care about the price of the stocks, just the relationship of them.
Over time, they will go up or down but at different rates. Let’s say they go up. Perhaps GM goes up 30% and F goes up 25%. You will make 30% profit on GM and lose 25% on F. But you don’t care about the loss in F, you only care about the net between the two stocks. So, in this case you made 5%.
But what was your investment? Mmmmmm. You want to talk to your broker and make sure that you can use the proceeds from shorting the F to pay for the long GM. If set up right, you will not have to put up any money at all! Amazing!
So basically you don’t care which way the market goes. You don’t care which way the auto industry goes. You only care about the relative movement between two stocks.
You have eliminated the risk of the market and sector and are left only with the relative risk of the two stocks. So this is a very low risk strategy!
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Thanks!
Good pairs trading,
Courtney Smith
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