Trading Pairs Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States With offices in North America, Europe, Australia, and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers’ professional and personal knowledge and understanding The Wiley Trading series features books by traders who have survived the market’s ever-changing temperament and have prospered—some by reinventing systems, others by getting back to basics Whether a novice trader, professional, or somewhere in between, these books will provide the advice and strategies needed to prosper today and well into the future For a list of available titles, please visit our Web site at www.WileyFinance.com Trading Pairs Capturing Profits and Hedging Risk with Statistical Arbitrage Strategies MARK WHISTLER John Wiley & Sons, Inc Copyright © 2004 by Mark Whistler All rights reserved Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923 978750-8400, fax 978-750-4470, or on the Web at www.copyright.com Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201-748-6011, fax 201-748-6008, e-mail: permcoordinator@wiley.com Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose No warranty may be created or extended by sales representatives or written sales materials The advice and strategies contained herein may not be suitable for your situation You should consult with a professional where appropriate Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages For general information on our other products and services, or technical support, please contact our Customer Care Department within the United States at 800-762-2974, outside the United States at 317-572-3993, or fax 317-572-4002 Wiley also publishes its books in a variety of electronic formats Some content that appears in print may not be available in electronic books For more information about Wiley products, visit our Web site at www.wiley.com Library of Congress Cataloging-in-Publication Data: Whistler, Mark Trading pairs : capturing profits and hedging risk with statistical arbitrage strategies / Mark Whistler p cm — (Wiley trading) Includes bibliographical references and index ISBN 0-471-58428-2 (cloth/cd-rom) Pairs trading Stocks I Title II Series HG4661.W46 2004 332.64’5—dc22 2004002263 Printed in the United States of America 10 Contents Acknowledgments Introduction CHAPTER The Nuts and Bolts What Are Pairs? xi xiii 1 How Do Pairs Work? Who Uses Pairs? Mindset of Reading This Book CHAPTER Why Fundamental Analysis? Common Sense China.com How Fundamental Analysis Relates to Pairs CHAPTER Market Basics Growth and Growth Ratios 12 Growth, PE, and the PEG Ratio 15 PE Ratio PEG Ratio Tying It All Together CHAPTER Technical Analysis Candlestick Charting Hammer Bottoms and Hangman Tops Doji Star 15 17 19 21 23 23 25 v vi CONTENTS Shooting Stars Engulfing Patterns 25 26 Support and Resistance 28 Trend Lines 28 Moving Averages 30 CHAPTER Technical Analysis Indicators 33 Stochastics 33 Chaikin Money Flow Oscillator 35 On-Balance Volume 36 Relative Strength Index 36 CHAPTER Basic Pairs Terminology 41 Understanding the Correlation 41 Spread, Differential, and Ratio 42 Spread Differential Ratio 43 43 43 Divergence Trading 44 Convergence Trading 45 CHAPTER Importing Data into Excel 47 CHAPTER Understanding Correlations—Steve Price 51 CHAPTER Correlation Simplified 59 What Is a Correlation? 59 Where to Find Correlations 59 Building a Correlation Using Excel 60 Contents vii CHAPTER 10 Understanding Stock Correlations in Relation to Indices 65 Why an Index? 65 What Is Beta? 65 How to Apply Beta 66 Where to Find Beta 67 CHAPTER 11 Basic Statistics Frequency Distribution 69 69 Mean/Median/Mode 71 Mean Deviation 71 Variance 71 Standard Deviation 72 CHAPTER 12 Excel and Statistics 75 Setting Up the Spreadsheet 75 Average, Median, Mode, and Standard Deviation 77 Understanding the Present Data 80 How Do You Know Which Stock to Buy or Short? 80 Charting the Data 83 CHAPTER 13 Differential versus Ratio 87 Differential 87 Ratio 88 CHAPTER 14 Applying Statistics to Pairs 89 Density Curve 89 Understanding the Data 92 CHAPTER 15 Taking a Step Back for a Moment 95 viii CONTENTS CHAPTER 16 Moving Averages and Normalized Standard Deviation 97 Differential Moving Average 97 Normalized Standard Deviation 99 CHAPTER 17 Money Management Why Money Management? 101 101 Psychology of Money Management 101 Understanding How Pairs Can Be Dangerous 103 CHAPTER 18 Money Management II 105 Fundamental Principles 105 Know Yourself 106 The Plan 106 CHAPTER 19 The Reality of Pairs 109 Do Pairs Really Work? 109 Trader or Investor? 113 Making the Style Work for You 113 Intraday Pairs 115 CHAPTER 20 Trading an Actual Pair Introduction 119 119 Trading Diary—The Beginning 120 Historical Time Line of Divergence Events 122 CHAPTER 21 The Current Setup Understanding Where the Pair Is Now Fundamentals Earnings Technical Analysis Statistics Summary 133 133 133 134 135 137 137 ix Contents Anadarko Petroleum Fundamentals Earnings Technical Analysis Statistics Summary 138 138 140 140 141 141 CHAPTER 22 Trading Diary 143 CHAPTER 23 Correlating Stocks to Indices 187 General Electric and ExxonMobil 187 General Electric and the DIAMONDS 189 ExxonMobil and the DIAMONDS 189 The Three Wise Men 193 CHAPTER 24 Option Basics—Scott P Evans 195 CHAPTER 25 Understanding Volatility 201 What Is Volatility? 201 Volatility Position Sizing in Your Spreadsheet 201 Volatility and the Individual Stock 204 Weighted Volatility 205 CHAPTER 26 Understanding Volatility and Options 207 Speed and Option Premium 207 Option Strategies for Pairs 208 Calls/Puts Covered Calls/Puts CHAPTER 27 Using Technical and Fundamental Analysis with Pairs 208 208 211 Technical Analysis 212 Moving Averages 212 265 Glossary Investment horizon: The length of time an investor plans to hold an investment Investment objective: When referring to a fund or manager, it is the expected result of the management When referring to an investor, it is what the investor hopes to achieve by investing Some examples would be growth or income Investment objectives are important because different objectives require different investments Growth investors hope to see the value of the stocks in their portfolio increase, while income investors need a regular income and would be better off owning an investment that paid regular dividends or interest Leverage: Anything multiplying the effect of a price change in an underlying security The most common form of leverage is margin borrowing Limit order: An order in which you state a specific price you will be buying or selling a security Liquidity: The ease with which an investment can be bought or sold Factors affecting liquidity are volume and the number of market participants Market capitalization: The total value of a company’s outstanding stock The number can be figured by multiplying the total number of shares outstanding by the stock price This can also be referred to as capitalization or a company’s capitalization Market order: An order to buy or sell a security in the open market at the first available price Mutual fund: A professionally managed account in which investors can pool their money to accomplish a common investment objective NASD: National Association of Securities Dealers, a self-regulatory agency, charged with maintaining high ethical standards and uniform practices among member firms NASDAQ: A real-time quotation and trading system set up by the NASD NYSE: New York Stock Exchange, the oldest and most prestigious market in the United States The NYSE is a self-regulatory agency similar to the NASD Passive management: The opposite of active management Passive management begins with a set portfolio that does not change Indexation is a common form of passive management Pullback: Written by future novelist, Andrew C Long (16 Years Old) A pullback occurs when the demand for a particular stock drops and with the demand goes the price This is good if you are waiting to buy the stock, but if you are already “riding the train” and trying to get off you’re in trouble 266 GLOSSARY QQQ: Also known as the Qs An exchange-traded fund designed to duplicate the performance of the NASDAQ 100 index REIT: Real estate investment trust They trade on an exchange and are managed portfolios of real estate Risk/reward ratio: A basic concept used in determining the merits of an investment It measures the expected return versus the maximum loss on an investment If you make money on 50 percent of your investments, a minimum ratio for an investment should be to For every $3 you expect to earn in profits, you are willing to risk losing $1 RIA: Registered investment advisor A company registered with a state or the Securities and Exchange Commission RIAs give investment advice on a fee-based basis Rule 12 (d)(1) Limit: Limits the amount of stock a mutual fund can hold in a particular issue SEC: Security Exchange Commission, created by congress in 1931 to oversee the investment industry Short sale: The practice of selling a security not currently owned in hopes of purchasing it at a lower price in the future Short sale rule: Requires that certain market conditions be met prior to entering an order to sell short Specialist: An exchange member responsible for keeping a fair and orderly market in a security during exchange hours Specialists are located on the floor of the exchange SPDRs: Also known as the spiders An exchange-traded fund designed to duplicate the performance of the S&P 500 index S&P 500 index: Standard and Poors 500 index An index comprised of 500 industry-leading companies Stop order: A two-part order The stop price, the first part of the order, is a price the security must trade at before the second part of the order may be activated Once the stop price is triggered, the order converts into a market order This order is difficult to understand, yet essential to your success Be sure to ask your broker for assistance when you are first learning to use this order Stop limit order: This order works like a stop order, but when the second part is activated it turns into a limit order This order is difficult to understand, yet essential to your success Be sure to ask your broker for assistance when you are first learning to use this order 267 Glossary Systematic investment plan: An investment strategy used to invest in open-ended mutual funds This is a good strategy for low-dollar investors It allows investors to invest a regular amount on a regular basis, as little as $25 and as often as twice a month These plans are good for smaller investors because there is generally no additional fee for the service Technical analysis: The use of charts and graphs to identify trends and price patterns that may predict future price movements Ticker: The symbol used to buy and sell an investment Third market: Trading of an exchange-listed security on the over-the-counter (OTC) market Top-down investing: The practice of focusing first on major market trends, then narrowing the view to specific industries and finally to individual stocks Value investing: Focusing on stocks with a low price-to-book ratio with a good dividend yield Volatility: The price fluctuation of the market, a fund, or an individual stock Volume: Usually measured on a daily basis It refers to the total number of shares traded on an exchange or an individual stock This is an important factor in technical analysis When compared over like periods, it is considered to give insight into the strength of a price movement Index A American options, 195 Anadarko Petroleum: fundamental analysis of, 138–142 trading diary for, 119–131, 143–185 Apache Oil: fundamental analysis of, 113–138 trading diary for, 119–131, 143–185 Arbitrage, defined, 1–2 Average, in Excel spreadsheet, 75–80 building in Excel, 60–64 explained, 41–42, 51–57, 59 indices and, 65–67, 230 where to find, 59–60 Covariance, 53–54 Covered call, 199 pairs and, 208–210 Covered puts, pairs and, 208–210 Cuddie, Kevin, 101 Current ratio, 19 B Beta: explained, 65–66 how to apply, 66–67 ratio and, 88 Biotech stocks, 231 Bloomberg terminals, 59–60 Book value, 134 Bubble, 237 D Data, see Excel spreadsheet; Statistics Day trading, see Intraday trading Debt-to-equity ratio, 19, 257 Density curve, 89–93, 95–96 used in Apache/Anadarko analysis, 145–184 Derivatives, see Options DIAMONDS, General Electric/ExxonMobil and, 189–193 Diary, see Trading diary Differential, 42–44, 87–88 Differential moving average (DMA), 97–98 applied to pairs, 212–213 Divergence trading, 44–45, 112–113 Doji star, 25, 26 C Call options, 195–200 pairs and, 208–210 Candlestick charting, 23–28 doji star, 25, 26 engulfing patterns, 26–28 hammer bottoms and hangman tops, 23–25 shooting stars, 25–26, 27 Cash, importance of company’s, 19 CBOE Volatility Index (VIX), 258 Chaikin Money Flow Oscillator, 35–36 Charts, 83–86 China.com, 6–8 Churning, 113 Classes of data, defining of, 69–70 Convergence trading, 45, 112 Correlation: E Earnings: of Anadarko Petroleum, 140 of Apache Oil, 134–135 cautions about trading in earnings season, 229, 231 researching growth in, 12–15 eBay, 225–227 Economic indicator reports, summary of, 239–253 269 270 INDEX I End-of-day (EOD) data, importing into Excel, 47–50 Engulfing patterns, 26–28 European options, 195 Evening Star pattern, 135–136 Excel spreadsheet: analyzing statistical data in, 80–83, 95–96 building correlation using, 60–64 charting statistical data in, 75–80, 83–86 density curve in, 90–91 importing data into, 47–50 monitor sheet in, 233–235 syntax and command vocabulary in, 60, 77 volatility position sizing in, 201–203 Exchange-traded fund (ETF), 189 Exponential moving average (EMA), 31–32 ExxonMobil: correlating to General Electric, 187–193 PE and, 218 volume and, 215 F Fear, as trading destroyer, 106 Float, 10–11 Foreign currency, options on, 196 Forward PE, 133–134 Frequency distribution, 69–70 Frequency of date, in correlation coefficient calculation, 56–57 Fundamental analysis, 5–8, 19–20 of Anadarko Petroleum, 138–142 of Apache Oil, 113–138 Apache Oil/Anadarko Petroleum trading diary, 119–131, 143–185 applied to pairs, 216–220 growth/PE/PEG and, 15–19 growth ratios and, 12–15 of KBH Homes and Toll Brothers, 220–225 liquidity and shares outstanding, 9–11 Futures, options on, 196–197 G Gaussian curve, 82–83, 258 General Electric, correlating to ExxonMobil, 187–193 Growth: growth ratios and, 12–15 PE and the PEG, 15–19 H Hammer bottoms, 23–25 Hangman tops, 23–25 Hedge funds, I Indices, 3, 65–67, 187–193, 230 Intel, 217 Internet, using for earnings reports, 12–14 Intraday trading, 4, 113 in earnings season, 229–230 risks of, 115–117 stock volatility and, 204 K KBH Homes, 220–225 L Lagging indicators, 21 Liquidity, and shares outstanding, 9–11 Losses, cutting of, 101–103 M Market bubble, 237 Market risk, defined, 66 Marsh McLennan, 226, 227 Mean deviation, 71 Median, 71, 75–80 Mode, 71, 75–80 Money management, 96 dangers of pairs trading, 103–104 importance of cutting losses, 101–103 principles of, 105–108 Monitor sheet, 233–235 Moving average convergence divergence (MACD), 213–214 Moving average, 30–32, 97–98 See also Simple moving average (SMA) applied to pairs, 212–213 stop loss points and, 225–227 N Naked call option, 197 Natenburg, Sheldon, 208 Normalized standard deviation, 99–100 271 Index O Oil industry, see Anadarko Petroleum; Apache Oil On-balance volume (OBV), 36, 37 Options: basics of trading, 195–200 volatility and, 207–210 Order flow, 116 “Outside” days, see Engulfing patterns Overtrading, 113 P Pairs trading, see also Intraday pairs; Trading diary author’s advice on, 226–231, 237–238 explained, 2–3 news events and, 110–113 terminology of, 41–45 work/attention required for, 109–110, 114–115 PEG ratio, 15, 17–19 Percentage loss stops, 106–107 Price-to-earnings (PE) ratio: applied to pairs, 216–219 calculating, 15–17 forward PE, 133–134 Price-to-sales ratio, 219–220 Put options, 195–200 pairs and, 208–210 Q QQQ, 189 Qualcomm, 219–220 R Ratio, 42–44, 88 strategy discussed in Apache/Anadarko analysis, 182–183 Relative strength index, 36, 38–39 Research, see Fundamental analysis Reverre, Stephane, 99 Risk, defined, 65–66 See also Money management S S&P 500, beta and, 65–66 Shooting stars, 25–26, 27 Simple moving average (SMA), 30–32 applied to pairs, 213 used in Apache/Anadarko analysis, 146–147, 171, 177–178, 180–181 Slippage, 257–258 SmartMoney.com, 217 Spread, 3, 42–44 Spreadsheet, see Excel spreadsheet Standard deviation, 52–53, 72–73 in Excel spreadsheet, 75–80 normalized, 99–100 stock volatility and, 204 used in Apache/Anadarko analysis, 148, 152–153 Statistical arbitrage, defined, See also Pairs trading Statistical stops, 108 Statistics: of Anadarko Petroleum, 141 analyzing/charting in Excel, 75–86, 95–96 of Apache Oil, 137 defined, 69 density curve and, 89–93, 95–96 frequency distribution, 69–70 mean deviation, 71 mean/median/mode, 71 risks of using, 103–104 standard deviation, 72–73 variance, 71–72 Stochastics, 33–35, 213–214 Stop loss points, 106–108 moving averages and trend lines, 225–227 used in Apache/Anadarko analysis, 144, 149–150, 161–162 Straddle, 200 Support and resistance, 28, 29, 225–227 Swing trading, T Technical analysis, 21–23 of Anadarko Petroleum, 140–141, 145–147 of Apache Oil, 135–136, 145–147 applied to pairs, 212–216 candlestick charting, 23–28 Chaikin Money Flow Oscillator, 35–36 of KBH Homes and Toll Brothers, 220–225 moving averages, 30–32 on–balance volume, 36, 37 relative strength index, 36, 38–39 stochastics, 33–35 272 INDEX I Technical analysis, (Continued) support and resistance, 28, 29 trend lines, 28–30 Technical stops, 107–108 Time, in correlation coefficient calculation, 56–57 Toll Brothers, 220–225 Topology.com, 59 Trading diary, Apache Oil/Anadarko Petroleum, 119–131, 143–185 Trailing PE, 16 Trend lines, 28–30, 225–227 V Variance, 52–54, 71–72 Volatility, see also Beta CBOE Volatility Index, 258 defined, 201 individual stocks and, 204 options and, 207–210 in sample spreadsheet, 201–203 weighted volatility, 205–206 Volume, 214–216 Y Yahoo.com: exporting data into Excel, 47–50 using for earnings reports, 12–14 About the CD-ROM INTRODUCTION Trading Pairs includes a CD-ROM with pairs spreadsheets/worksheets in Excel that aim to help investors track multiple pairs positions The individual sheets are supported by market data that can be downloaded free from Yahoo.com The worksheets aid investors in analyzing the descriptive statistics of their pairs Each sheet is part of a larger network of sheets that funnel all data into one main sheet called the Monitor Page By updating the data on a weekly—or daily—basis, pairs enthusiasts have a way to easily track where many pairs are at one time Though the sheets are not intended to directly produce trading signals, they assist in keeping a close eye on where an investor’s pairs’ of interest are The individual sheets include the historical statistics, standard deviations, the density curve, volatility measurements, data, and charts An Excel viewer has been provided on this CD-ROM for readers who not own MS excel software However, MS Excel is recommended for optimum usage of this ancillary product CD-ROM TABLE OF CONTENTS Excel Viewer MONITOR PAGE.xls - Main tracking page for all spreadsheets Individual sheets included on the Monitor Sheet (in alphabetical order): AA-AL.xls - ALCOA Inc & Alcan Inc 273 274 TRADING PAIRS ABGX-PDLI.xls - Abgenix, Inc & Protein Design Labs Inc ABX-NEM.xls - Barrick Gold Corp & Placer Dome Inc AEM-PDG.xls - Placer Dome Inc & Agnico-Eagle Mines Ltd ALTR-LSCC.xls - Altera Corp & Lattice Semiconductor Corp AMAT-MU.xls - Applied Materials Inc & Micron Technology Inc AMAT-TER.xls - Applied Materials Inc & Teradyne Inc AMGN-CHIR.xls - Amgen Inc & Chiron Corp APA-APC.xls - Apache Corp & Stone Energy Corp APA-EOG.xls - Apache Corp & EOG Resources Inc APA-MUR.xls - Apache Corp & Murphy Oil Corp APA-NBL.xls - Apache Corp & Noble Energy Inc APA-SGY.xls - Apache Corp & Stone Energy Corp APD-PX.xls - Air Products and Chemicals Inc & Praxair Inc ATK-LLL.xls - Alliant Techsystems Inc & L-3 Communications Holdings, Inc AU-PDG.xls - AngloGold Ltd & Placer Dome Inc BBY-CC.xls - Best Buy Co Inc & Circuit City Stores Inc BNI-CSX.xls - Burlington Northern Santa Fe Corp & CSX Corp BNI-UNP.xls - Burlington Northern Santa Fe Corp & Union Pacific Corp BP-CVX.xls - BP PLC & ChevronTexaco Corp COST-WMT.xls - Costco Wholesale Corp & Wal-Mart Stores Inc CTX-TOL.xls - Centex Corp & Toll Brothers Inc CMI-CAT.xls - Cummins Inc & Caterpillar Inc DD-PPG.xls - E.I Du Pont De Nemours & Co & PPG Industries Inc DF-KFT.xls - Dean Foods Co & Kraft Foods Inc DIA-SPY.xls - DIAMONDS Trust, Series & S&P SPDRs ELN-ICOS.xls - Elan Corp PLC & Icos Corp EMN-PPG.xls - Eastman Chemical Co & PPG Industries Inc EOG-APA.xls - EOG Resources Inc & Apache Corp EOG-BR.xls - EOG Resources Inc & Burlington Resources Inc EOG-NBL.xls - EOG Resources Inc & Noble Energy Inc FCS-LSCC.xls - Fairchild Semiconductor Corp & Lattice Semiconductor Corp About the CD-ROM 275 HD-KSS.xls - Home Depot Inc & Kohl’s Corp HD-LOW.xls - Home Depot Inc & Lowe’s Cos Inc HLYW-MOVI.xls - Hollywood Entertainment Corp & Movie Gallery Inc INTC-LSCC.xls - Intel Corp & Lattice Semiconductor Corp IP-BCC.xls - International Paper Co & Boise Cascade Corp IR-PH.xls - Ingersoll-Rand Co Ltd & Parker Hannifin Corp JBHT-HTLD.xls - JB Hunt Transport Services Inc & Heartland Express Inc KBH-LEN.xls - KB Home & Lennar Corp KBH-RYL.xls - KB Home & Ryland Group Inc KLAC-NVLS.xls - KLA Tencor Corp & Novellus Systems Inc KMX-SAH.xls - Carmax Inc & Sonic Automotive Inc KSS-LOW.xls - Kohl’s Corp & Lowe’s Cos Inc LEH-GS.xls - Lehman Brothers Holdings Inc & The Goldman Sachs Group Inc LLTC-LSCC.xls - Linear Technology Corp & Lattice Semiconductor Corp LLTC-MXIM.xls - Linear Technology Corp & Maxim Integrated Products Inc LLTC-QLGC.xls - Linear Technology Corp & QLogic Corp LMT-BA.xls - Lockheed Martin Corp & The Boeing Co LMT-LLL.xls - Lockheed Martin Corp & L-3 Communications Holdings, Inc MEDX-PDLI.xls - Medarex Inc & Protein Design Labs Inc MER-GS.xls - MERRILL LYNCH & The Goldman Sachs Group Inc MER-MWD.xls - MERRILL LYNCH & MORGAN STANLEY MERQ-BEAS.xls - Mercury Interactive Corp & BEA Systems Inc MERQ-VRTS.xls - Mercury Interactive Corp & Veritas Software Corp MLNM-HGSI.xls - Millennium Pharmaceuticals Inc & Human Genome Sciences Inc MLNM-MEDX.xls - Millennium Pharmaceuticals Inc & Medarex Inc MLNM-PDLI.xls - Millennium Pharmaceuticals Inc & Protein Design Labs Inc MO-RJR.xls - Altria Group Inc & R.J Reynolds Tobacco Holdings Inc MWD-GS.xls - MORGAN STANLEY & The Goldman Sachs Group Inc MYG-WHR.xls - Maytag Corp & Whirlpool Corp NEM-AEM.xls - Newmont Mining Corp & Agnico-Eagle Mines Ltd 276 TRADING PAIRS NEM-AU.xls - Newmont Mining Corp & AngloGold Ltd NEM-PDG.xls - Newmont Mining Corp & Placer Dome Inc PHM-TOL.xls - Pulte Homes & Toll Brothers Inc PNC-KEY.xls - The PNC Financial Services Group & Keycorp PNC-MEL.xls - The PNC Financial Services Group & Mellon Financial Corp RCL-CCL.xls - Royal Caribbean Cruises Ltd ASA & Carnival Corp RD-SC.xls - Royal Dutch Petroleum Co & Shell Transport & Trading Co PLC RYL-LEN.xls - Ryland Group Inc & Lennar Corp SGY-APC.xls - Stone Energy Corp & Anadarko Petroleum Corp SMH-NVLS.xls - Semiconductor Holders Trust & Novellus Systems Inc SPC-XL.xls - St Paul Companies Inc & XL Capital Ltd SSP-GCI.xls - EW Scripps Co & Gannett Co Inc TER-MU.xls - Teradyne Inc & Micron Technology Inc TGT-WMT.xls - Target Corp & Wal-Mart Stores Inc TOL-KBH.xls - Toll Brothers Inc & KB Home TQNT-NVLS.xls - Triquint Semiconductor Inc & Novellus Systems Inc WERN-YELL.xls - Werner Enterprises Inc & Yellow Roadway Corporation XOM-CVX.xls - Exxon Mobil Corp & ChevronTexaco Corp All sheets represented as APA-APC 00.00.00.xls correspond with a date referenced in Chapter 22, Trading Diary Example_pairs_sheet1.xls—Sample spreadsheet referenced in Chapter 12 Example_pairs_sheet2.xls—Additional sample spreadsheet to assist readers in building their own sheets General Electric-Exxon Mobil.xls—Spreadsheet referenced in Chapter 23 DIA-Exxon Mobil.xls—Spreadsheet referenced in Chapter 23 DIA-GE.xls—Spreadsheet referenced in Chapter 23 MINIMUM SYSTEM REQUIREMENTS Make sure that your computer meets the minimum system requirements listed in this section If your computer doesn’t match up to most of these requirements, you may have a problem using the contents of the CD About the CD-ROM 277 For Windows 98, or above: • PC with a Pentium processor running at 120 Mhz or faster • At least 32 MB of total RAM installed on your computer; for best performance, we recommend at least 64 MB • A CD-ROM drive • Microsoft Excel For Macintosh: • Mac OS computer with a 68040 or faster processor running OS 7.6 or later • At least 32 MB of total RAM installed on your computer; for best performance, we recommend at least 64 MB • A CD-ROM drive • Microsoft Excel (An Excel viewer has been provided on this CD-ROM for readers who not own MS excel software However, MS Excel is recommended for optimum usage of this ancillary product.) USING THE CD WITH WINDOWS To install the items from the CD to your hard drive, follow these steps: Insert the CD into your computer’s CD-ROM drive A window appears with the following options: Install, Explore, Links, and Exit Install: Gives you the option to install the supplied software and/or the author-created samples on the CD-ROM Explore: Enables you to view the contents of the CD-ROM in its directory structure Exit: Closes the autorun window If you not have autorun enabled, or if the autorun window does not appear, follow these steps to access the CD: Click Start @> Run In the dialog box that appears, type d:\setup.exe, where d is the letter of your CD-ROM drive This brings up the autorun window described in the preceding set of steps Choose the Install, Explore, or Exit option from the menu (See Step in the preceding list for a description of these options.) 278 TRADING PAIRS USING THE CD WITH THE MAC OS To install the items from the CD to your hard drive, follow these steps: Insert the CD into your CD-ROM drive Double-click the icon for the CD after it appears on the desktop Most programs come with installers; for those, simply open the program’s folder on the CD and double-click the Install or Installer icon Note: To install some programs, just drag the program’s folder from the CD window and drop it on your hard drive icon TROUBLESHOOTING If you have difficulty installing or using any of the materials on the companion CD, try the following solutions: • Turn off any antivirus software that you may have running Installers sometimes mimic virus activity and can make your computer incorrectly believe that it is being infected by a virus (Be sure to turn the antivirus software back on later.) • Close all running programs The more programs you’re running, the less memory is available to other programs Installers also typically update files and programs; if you keep other programs running, installation may not work properly • Reference the ReadMe: Please refer to the ReadMe file located at the root of the CD-ROM for the latest product information at the time of publication If you still have trouble with the CD-ROM, please call the Wiley Product Technical Support phone number: (800) 762-2974 Outside the United States, call 1(317) 572-3994 You can also contact Wiley Product Technical Support at www.wiley.com/techsupport Wiley Publishing will provide technical support only for installation and other general quality control items; for technical support on the applications themselves, consult the program’s vendor or author To place additional orders or to request information about other Wiley products, please call (800) 225-5945 About the CD-ROM 279 USING THE SOFTWARE Each file is a tracking Excel spreadsheet that can be used to better understand pairs trading By updating the data on a weekly—or daily—basis, pairs enthusiasts have a way to easily track where many pairs are at one time USER ASSISTANCE If you have questions about the software, please contact John Wiley and Sons If you need assistance or have a damaged disk, please contact Wiley Technical Support at: Phone: (201) 748-6753 Fax: (201) 748-6800 (Attention: Wiley Technical Support) Email: http://www.wiley.com/techsupport To place additional orders or to request information about Wiley products, please call (800) 225-5945 ... current paradigm of the market xiii Trading Pairs CHAPTER The Nuts and Bolts What Are Pairs? How Do Pairs Work? Who Uses Pairs? Mindset of Reading This Book WHAT ARE PAIRS? Where there is a relationship,... the term pairs trading interchangeably with statistical arbitrage, thus eliminating any possible conflict of semantics So what exactly is pairs trading and/or statistical arbitrage? Pairs trading. .. distinctive paradigm of trading than the typical buyand-hold strategy Pairs trading is by no means the “holy grail” of trading and will have its ups and downs, like any other trading style However,