Home / Finance / Using a Pair Trade

Using a Pair Trade

The Consumer Staples sector of the S&P 500 index has been one of the better performers in 2016, as many market participants looked for safe haven stocks to defend against volatile markets conditions.  During this period stocks such as Coca Cola have outperformed reaching fresh all-time highs leading the S&P 500 index higher.

The staples sector increased slightly more than 3% during the first 3.5 month of 2016.  The sector recently broke above a 1½-year up trend line, suggests higher prices are to come. Note that the price has also been above its 65-week exponential moving average since the beginning of 2009 thereby demonstrating that an uptrend is in place.

Using a Pair Trade

The ratio between the two consumer sectors, staples and discretionary has whipsawed reversing 3-times over the past decade. The latest penetration took place at the turn of the year and was supported by a MACD crossover which shows that staples are outperforming.

Consumer cyclicals have been a stellar performer since 2009 but that may be about to change. First, the price has violated a secondary up trend line. It’s a fairly impressive one due to its length, but also, because it has been touched or approached on numerous occasions. The violation is, therefore, the equivalent of the breaking of a major support zone.

If investors are looking for a risk on trade but are interested in offsetting that with a staple, a pair trade is a great market neutral trade.  A market neutral trade is one where an investor is long a stock and simultaneously short another stock.  This means that if the broader markets rise or fall, the investors is not exposure to this type of price action.  The investor is only exposed to the difference in performance between one stock and another.

stock and another

An example of a pair trade is one where you trade a stock like McDonalds which is a consumer discretionary stock and simultaneously sell at stock like Coke which is a consumer staple. As you can see over the past 5-years, Coke has Outperformed McDonalds, pushing the ration between the two stocks down to 0.50.  The ratio has recently rebounded but to reach the 200-week moving average the ratio would need to climb an additional 40%.  This likely represents an excellent opportunity if you believe there will be strong growth and discretionary stock will outperform safe stocks such as consumer staples.

About Abram Jayce

Check Also

Choosing the Best Credit Monitoring Service based on Price

Are you building your credit? Have you taken precautions? You may wonder why. The simple ...