# High-Risk, High-Return #Trading #Strategy : #Pair Trading | #Learn2Trade Session 41

Welcoming you all to Learn2Trade session #41 my name is Vivek Bajaj and I’m teaching Trading to you and Annapurna Ji. Hello -Hello sir. -How are you? -All good sir. Very good. So, Annapurna Ji what we had done in last 40 sessions is that we have learnt basics of technical We learnt a strategy, concept of relative strength and we learnt about options. -Right. And in options how we can trade with the strategy we have developed. I had said I covered basics of options. Not gone into much deep advanced because many deeply it can go. So, now it’s upon you if you want to go to next level or not. I want to take back you to a video Which I recorded many months ago. In my YouTube channel, I had made a video

“In 14 minutes know the 8 ways to trade in the Share Market.” So, basically 8 strategies Which are typically deployed by people in the stock market. -Okay. -You had seen the video? By any chance. -Yes sir, I had seen. -Seen? -Yes. -So, many people have seen. 350K+ people Have seen and a nice video. Good. I think overall people liked it. So, see over there Someone has said that exactly what are the strategies I talked about. I talked about Arbitrage Strategy, Spread Trading, Jobbing/Scalping, Technical Strategy, Pair Trading, Options Strategies Quant Strategy & finally Multi Asset Trading. Okay? In this video I had told I will slowly touch these

And will tell you. -Yes. -So, Annapurna Ji I have told some things about some strategies. So, let’s revise these quickly. Firstly, Arbitrage Strategy. It’s very simple that when same stock Is being traded in two different exchanges, then in them Arbitrage can happen. Arbitrage

Meaning freelance, price difference. If Reliance is trading in BSE at suppose 2400 And in NSE at 2410. Is it correct? -No. -Should not happen. Reliance is Reliance. Stock is stock There is no stock which is listed differently in NSE and differently in BSE. So, whenever There is a difference of price, take it at 2400 and sell it at 2410. -Okay.

And when that difference reduces then your money is made. -Right. So, suppose in NSE, it’s 2400 and you take it and 2410 at BSE so you sell at 2410 So, your money is made? -Sir, there is brokerage too. -Brokerage is there. Transaction cost is put So, all that brokerage and transaction cost sums up to 6/- So, in net 4 rupees is saved? -Right. Not saved. -How? -How not saved? When you took the share from NSE. So, that share will come At T+2 meaning will come day after tomorrow. -Right. -And the one you sold at BSE, that you Would have to give T+2. First, you would have to give, then it comes because pay-in is first

And pay-out is happened later. So, if you have to give then you don’t have the share. -No. So, how will you work? Generally, who do this, they keep a lot of shares with them. Such that where we have to sell, there we sell it and then when it comes it’s already in my kitty. So, anyone who has taken large-cap stock, he knows he has to invest, he doesn’t have to sell anytime. So, what will he do typically? If there is any spread or arbitrage opportunity seen between the gap Then would want to capitalize it. Before, manually it used to happen. One side NSE exchange

And the other BSE Terminal and we used to trade rapidly. But now as algo’s and machines have come. Then, this whole work of arbitrage is done by machines. Because between both the exchanges There is a dedicated lease line correctly. So, fastest access of data and transaction is done Through that lease line correctly. So, arbitrage that used to happen a lot before. Now for a common man to find out arbitrage opportunities are tough. Second strategy,

Spread strategy. If you see that video, then I told in more detail but I’m refreshing rapidly Second spread strategy meaning, same underlined has multiple instruments like reliance So, it has future contract, options contract and in future too there is October, September expiry December expiry, every expiry has its own relevance. Every expiry has its own price. Because the one expiring after will have different price, and the one after 2 months will have something else. Then this spread trading, we used to predict that the gap in both instruments will dec. or inc. Like so many strike prices are present in Reliance, then 4000, assuming that it will go But I am taking call option of 2400 and selling call option of 2600 this means that the spread between the both options, I’m trading in that. And why I’m taking and selling?

Because I want this spread to decrease. Money will be made if it dec. And if spread inc. money is used. Right. -So, spread is technically same underlined but different instruments. -Okay. Third Strategy Is Jobbing/Scalping meaning I’m trading the whole day so to influence every instrument There are specific instruments that create many impacts on it. For example, if we talk about Reliance As Reliance has big weightage on NIFTY and if it moves then Reliance will move too. So, what jobbing/scaping people do? Analyze the depth of the market that what are the top 5 Buyer-seller doing, what the overall market is doing! And trade continuously in the market Which is scalping, jobbing. Sometime, I will show jobbing/scalping live too. But it’s not for you.

So, basically arbitrage, spread and jobbing, these join big professionals and trading firms And they keep on doing this every time. Their work is this only. But you aren’t a professional trader You are wanting to join with broker and work on your capital, so you belong to a different type Anyone in full time employment or associate with any broking firm like many people are joined with our prop desk so they work with any of these 3 strategies. 4th strategy is technical strategy. I have taught you this in Learn2Trade, how you can do with technical analysis, 5th Strategy is Pair Trading, this is a very nice strategy which we will a little bit today. 6th Strategy is Options

Strategies. What did I teach you in this? Delta, Theta & Vega, you have to do friendship with them And make a market view, if you want to play delta. And if you want to work with Theta Then obviously you have time decade with which you can make money. And Vega obviously You would have to give because Volatility will increase or decrease will be decided by your strategy Your money will be made or not. So, options strategy is getting deeper into those option Greeks After that it’s quant strategy. Its s very interesting and is used mostly by algo traders.

Quant can be anything. Anything expressed in form of numbers is Quant. For example, You can make a strategy that from morning 12 to 12 what happens in NIFTY, historically We have seen typically NIFTY behaves like this and based on that historical behavior. You make a probabilistic model and based on that model you run your model. -Okay.

So, quant is creating your own algorithms. If you want to understand about Quant, then In Face2Face, I have recorded many videos on Algo-Trading with many people, you go and watch them You will have a very nice understanding what is Quant. -Okay. -And the last, which I want you to become Eventually is Multi Asses Trader meaning I understand equity, commodity, currency, the relation between all and I’m trading in all assets where I feel the opportunity I trade accordingly. Okay. -So, I have told equity till the 41 episodes and now we in the coming days commodities And using that knowledge how we can trade commodities and how can trade equities from Commodities knowledge, will talk about it and how you can trade currency, how can you trade Equity using currency, will talk about it and more or less our 50 videos will be over. You will be able to become a multi asset trader. But seeing those 50 videos

can you become multi asst trader? -Little practice have to be done sir. -Yes. To become a typical multi-asset trader, you would have to give 4-5 years of yours because till the time you don’t see a market cycle, till then you won’t understand how does this work. To start, equity-cash market is fine then options, then commodities, then currency and accordingly plan our journey then in 4-5 years you will become a multi-asset trader because you will have to put a lot of capital. Then it won’t

be done from 1-2 Lacs. To become a multi asset trader, you must have a capital of 10Lacs. And to put capital of 10Lacs, conviction would come when a similar knowledge would develop Okay. -So, today we will touch PAIR TRADING. What is it? What do you think listening to it? Trading in 2 different instruments. -Fantastic. Trading in 2 different instruments. Taking a position in one And taking counter position in the other one like I’m liking this and I’m not liking the other So, what I’m liking, I will take it and the one I’m not liking it, I will sell it. There are 2 types of

Pair Trading Strategy 1. Statistical Pair Trading & 2. Relative Strength Pair Trading. Will talk about both. Statistical Pair Trading – You might have learnt the concept of Mean Deviation in Stats in school. What does it say? Everything has a mean and if something goes far from mean then There is chance it comes back to the mean which is a normal distribution curve.

Then statistics say that between any 2 instruments a relationship existing that if you divide Or subtract it. Suppose, HDFC Bank & ICICI Bank. These 2 are related instruments. -Yes sir. Similar kind of instruments. Obviously when you talk about taking out relationship then you do with similar people. It’s not like you take out difference from Mukesh Bhai and Me. Where he is and where I am. But we can compare ourselves with our friends.

So, whenever we are talking about pair trading, we are talking about related instruments Like banking stocks related, FMCG is related on its own or Pharma to an extent is related on its own. The biggest benefit of Pair Trading is that you make the market risk ZERO. Suppose for some reason, There is excessive recession in the market and you have taken one and sold the other. What you have taken? Strong one. And what have you sold? Weak one. So, when the market falls The strong will fall too but weak will fall more. So, as you have taken strong and sold weak. And as weak should fall more, then money will be made in net. So, you are basically nullifying

The market risk by trading pair. As a professional trader, you have to go in that zone slowly Because the advantage of pair trading which is nullifying the market risk is very big advantage. You would want a situation where market risk will nullify because want to sleep at night I don’t want to see. I have taken strong and sold weak, should be sufficient for my journey as a pair trader.

Now how you can do pair trading? If you do in cash market, then you take share of strong stock, But how will you sell the weak stock? -Short selling. -That can happen in Intra Day. How will it be done overnight? Sir, options. - So, this means pair trading is difficult in cash market, you can do with futures For which you need very much capital or you will have to use options for trading. One thing can be done Can buy in cash market, and sell in options. -Right sir. -So, pair training as I said statistical pair trading And relative strength pair trading. statistical pair trading believes if something has gone down too far Then chances are there it comes near to mean. So, when will it go far? When numerator denominator

Let’s talk about divisibility once. Numerator / Denominator. So, if the typical gap is this much And the gap is so much which means the numerator has moved so fast or the denominator Then eventually they will get normalized at a point. This is the story. -Right. -what does pair trader do? If the numerator has moved fast then sell the numerator and take the denominator. Go reverse in the numerator. -Right. – moves more fast sell it and take more denominator.

Because it is assumed that the numerator is moving for waste, why left the denominator? Then chances are that that the numerator will become more less or denominator will follow it. The one running fast, sell it. And the one can’t run, buy it. It’s a thought process that is pure statistical pair trading. Second thought process is relative strength. It says that if it’s running then it’s running for a reason. It’s strong that’s why it’s running so take it and the one not running sell it. Reverse thought.

statistical pair trading says mean reversal meaning the one running is wrong. The one not running why would we keep in due! Take it too. Like for everyone say, ITC didn’t run only. HUL moved so much. Meaning second people say that the strong ones should be taken that ITC should be sold And HUL should be bought because HUL is strong and there is some reason behind it. So, which school do you belong to? -If you have taught me relative strength then I would go with RS. See, the first one is not possible for we both because for that very much will is needed because going reverse Selling the boom stock then the big people do it. And they will have to sell it at every price. There is no stoploss. If we talk about individual participants then we should always work with RS

Meaning take the strong stock and sell the weak stock. Now how we will do it? So, let me give a model here. Let’s open a chart for you. Chart > New Model. Very interesting science it is. Focus on it. Let’s take ICICI example In trading view there is a facility that you can make divisibility of pair. You can track the pair too. That how the divisibility is working. So, you make a new watchlist named Pair. Trading view is a very good platform to do this. You add it. Symbol, I want ICICI bank / HDFC bank

Or the reverse, anything can be done. Doesn’t matter. Then we make a pair, add ICICI bank Divided by HDFC bank. Then this divisible came. And if you enter then over here the decimal came. 0.45 because price of ICICI is half the price of HDFC. In terms or price. This not means company is half. 0.45 meaning ICICI bank is above and HDFC bank is below. And let me add both of them too. And there is reason why I’m adding it. Let me call this my daily chart. See this on daily basis So, this is my pair. Let me line chart it, removing the candle. This means it is up trending meaning

ICICI bank is outperforming HDFC bank. Then typical statistical arbitrage will sell at every price Saying the difference will come down. Because if you see how the difference worked historically Every time it comes near the mean. Will go down and again come up and go down. This is the thing. This is the normal distribution curve. It always come near the mean and this is the long-term average. So, assumption will be that it will come back to the mean. But it many not hold because there

Might be such a change in bank resulting in its outperformance. You understood this concept? And in this let me just add relative strength, our RS. So, I added it. We had done it for a period of 55 You remember? -Yes sir. -And I’m removing the reference level. I’m not doing RS for this

because I don’t want to look at the RS of this pair, but have to see the RS of both individually. So, ICICI Bank is an outperformer and HDFC is an underperformer. Then my model is even saying same That this is outperforming and this is underperforming and ratios is even saying the same. So, What will I trade? I will long the ICICI bank and short the HDFC bank. Till when? Till the time trend is upwards For trend which indicator do we use? -Super trend. -Absolutely. So, let’s add super trend.

When it’s made then what is the tension? Add it. This is super trend. Super trend is saying it’s below. So, I will square up this trade. When it will tell me again green, then I will enter the trade again. Why enter? Because this is even saying ICICI bank is strong and HDFC is weak. -HDFC’s super trend is positive I’m not looking at that. I will just look at the super trend of the spread. If it’s positive, then I will take.

If it’s negative then I won’t. I won’t sell this spread because you can sell it. For that what will you do? Sell ICICI Bank & take HDFC Bank. But I won’t do that. Why? Because ICICI is still strong & HDFC weak according to RS study If it becomes reverse then I will sell this spread because super trend is negative. HDFC has become stronger And ICICI bank has become weaker. Let’s take some other pair. We would have to find pairs like this Where there is relationship, business is similar. I cannot compare class 8 and class 10 student.

I cannot compare pharma and banking stock. -Can we compare a stock with indices? -Yes. Like BANK NIFTY? -Bank Nifty- nifty can be done. But if you have done reliance with nifty, Then in nifty there are so many stocks. If any stock gave reverse view, then your whole trade can be wrong.

Preferably do stock to stock, stock to index is risky. Let’s go to stock to stock and do ITC & HUL. So, ITC/HUL. Actually, it should be done reverse because HUL price is more otherwise decimal would be very much HUL/ITC. Its ratio is 13. I’m adding a space. INSERT > SECTION. Inserted one so now each section is made.

Now I have to add HUL, so adding the stock price is here and ITC over here. Look at the ratio. What is it doing? This is HUL/ITC. This is green. This means I will take HUL and sell ITC. Why? What is HUL’s RS saying? Strong. And what is ITC RS saying? Weak. So, I have got a confidence that the talk is right, stock is strong

And this stock is weak then I can work in this ratio because ratio is even showing me strength. Sir, if I sell then at what point should I sell? Current price. - At the money. The near price. You were talking about Options. -Yes sir. -When you work under Options, if you want to play boom,

then you can play while taking call or by selling put. If you want to play recession, then reverse. -Right. Now it depends on how much capital you have. If you have to work while taking only, then Take one’s call and other’s put. -Right. -But time value will beat you. If you can work with selling Then sell one’s call and other’s put and premium would come home. -Right. -Sell the boom put And the recession call. Or if you want to do both, then you can judge according to the value of options premium

If it is high, then how to identify? Implied volatility. If the volatility is high, then premium price Is high. So, if you sell then you have more benefit. And if you take it then you have less benefit. So, generally the call is less in ITC. So, will you take the ITC put? -Yes. -Why? Because you want to play recession And sell put of HUL. Why? Because you are getting more premium. So, you would have to judge the volatility, The premium value and then after that you can do pair trading with options. This is a very good

Strategy who deploys in future because it’s easier. Take one and sell the other. And in future there is very much margin deployment. -If I want to take a stock in cash market and sell options. You can do that too. You take HUL in cash and sell the call option of ITC, if you don’t feel there is no boom in ITC. And sell the upper call of HUL that it won’t go above this. See, you can do a lot of permutation combination

As it is said options has too many options. And if you want you can use it to your advantage. But to straightforward it, that you work in ‘at the money’ options. ‘At the money’ HUL, if you want to play boom Then you take and play recession in ITC then take ‘at the money’ put. In this your premium investment is limited. If the price remains there only, then because of time value your money will be used and If the value is volatile then your money would come. -Okay. -Pair trading is a next level trading technique. I actually was thinking should I say or not because at this stage you may not like to do pair trading.

But because we are covering this gambit of trading then I think a basic understanding of pair trading is important Such that it sets in your mind, not necessary you have to trade. But understand the concept, it’s so interesting? Yes sir. - It negates the market risk and it’s saying you the ratio that to work in which pair. Where to play boom and recession. -Right. -So how to identify pairs? Like I said make pairs of commonly used sector stocks

You can go to web.stockedge.com, over there when you go to sector, then there are so many sectors. Which ever sector that you like, that you understand. Or the sectors in derivatives, the stocks And pair the stocks after identifying. To pair it even there is a scientific manner, whenever you You take out co-relationship of 2 instrument, co-relation that you had learnt in statistics If the correlation is high, this means they are worth to be compared. And any correlation above 0.5 is decent So, after downloading every stock price, seeing the last 6 months data, take out the correlation And by that you will find out the pair having high correlation and in that I can trade.

So basically, major gainers and losers. Major gainer/ major loser if I do then that is good? No. you will have to analyze on the business level which is good pair to pair. Like ICICI-HDFC is a good pair. Because if you search in private banks then, those are one of the top banks. So, you can pair them

Because their business model is more or less same. Whenever pairing is done, statistically Looking at historical data pf prices and find the co-relationship and do. Or according to business model You can pair the stocks. Then this sector details in StockEdge, if you look at these sectors then

You will get stocks where you can pair like FMCG, suppose consumer durable, In consumer durable there is AC, then Voltas-blue star can be paired. But this can pair only if it’s in derivatives Because ultimately you will trade in derivatives. Cannot be traded in cash market. -Right. Understood the concept? This is just the starting of pair trading, obviously if we go deep into it Then it’s a big course in its own on how to do pair trading. But understood the concept in basic level

You can google too. You will get a lot of material. You will get an understanding of how to do statistical pair trading. -Okay sir. So, this was the basic concept of pair trading and what strategies you can use. I didn’t go much deep Because I don’t want you all to go into pair trading now because this is a complicated science In this the most critical is exit because if you are going wrong in any pair, then when and how you will exit Would be little difficult. I use super trend here because I can define my exit systematically rather than

A discretionary. But many people plan exit in some other way. Then it’s a different science in which I won’t go. But hoping you understood this and if you want to implement more on this strategy Then study from the resources available on internet, and practice yourselves, analyze it, download some data from NSE website and start making your own analysis from that data Thankyou friends for staying with my channel and definitely wait for the next video. Bye-Bye.

*2021-09-20 04:30*