Pair Trade Example
Research for Online Investors

by John Dalt

2/18/10

One of the most popular pair trade techniques is to profit off a market disparity as it returns to normal. We wrote about “Pair Trades” earlier this year, you can read Intro. To Pair Trades in Investor Resources for background.

We looked for pair trades today for pricing disparity, and found another lesson that might be worth mentioning. What if we looked at Gold priced in a specific currency? We know gold is a commodity that trades on a worldwide basis, so it will price accordingly in each currency, depending on the relative value of that currency to other currencies.

Below is a chart of the relationship of the FXE etf to the GLD etf.  These ETFs represent the Euro and gold.  It shows the shares of GLD it takes to buy one share of FXE.  It has gone down in the last three years from over two to 1.24 at close yesterday.

Looking at this chart we may want to jump and buy FXE and short GLD, but wait, let’s look at the dollar and GLD.

It looks very similar.  Our judgment is that the trade may not be valid because the price of gold has increased in all currencies.  Maybe there is a trade in the relationship of the two currencies.  Let’s look at how many shares of UUP (dollar) it takes to buy one share of FXE (euro).

The relationship in the two currencies is right in the middle, without an extreme to correct.  We would want to check this in one month for an extreme situation to develop.  Then we will enter the trade for a correction and a return to the mean.

I hope this helps you as an example to investigate further, before making a trade that could end badly.

To the Mailbag:   “I wonder why Ford (F) stock is not taking off on Toyota’s troubles.”---paid up subscriber T.M.

John’s Response:   Toyota’s legal exposure could hit $10 billion in the next few years.  Ford will benefit, I have been watching it.  They are trading too close to their highs for my taste.  I would look for a buy at $11.50 or wait for a breakout above the 52 week high.  This could signal a nice climb to $13.20+  This was the stock price five years ago.  This would be an IBD style play.

“I am new to Forex, please review another pair currency or gold and silver for trading.”----subscriber T.Y.

John’s response: Whoa, I know nothing of FOREX and would advise caution. I love to trade commodity ETFs and commodity producers as an inflation trade and supply/demand trade, but would advise caution in your new venture. The marketing people are excellent, but…the trades are difficult.  Like they say about Vegas, "Somebody has to pay for the lights!"

“We can solve the Full Body Scan controversy with a booth that passengers step into.  The booth will scan and detonate any explosives on the occupant.” ---subscriber R.L.

John’s response:   Sounds like it turns a terrorist into a belch of smoke!  Good idea.

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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