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Here we will breakdown the how's and why's of the Convergence Pairtrade feature. We provide you with a more detailed understanding of how to benefit from this tool.

1. What is a Convergence Pairtrade, and how does it work?
2. Why does the Convergence Pairtrade work?
3. How do I access the Convergence Pairtrade Live Picks at Tradetrek.com?
4. How do I read and understand the Pairtrade chart?
5. How do I trade stocks following the Convergence Pairtrade strategy?

What is a Convergence Pairtrade, and how does it work?

There are two types of Pairtrades: Convergence Pairtrades and Divergence Pairtrades. This section covers the Convergence Pairtrade. A Convergence Pairtrade is a trade between two stocks that exhibit a stable relationship between them. For example, stocks that often move up or down together or stocks that follow each other closely might be good candidate stocks for a Convergence Pairtrade. In general, it is a good idea to choose stocks from the same industry sector (so if, say, some bad news affect the whole sector, both stocks get affected in the same way), and to look at large sectors (e.g., regional banks, the energy sector, semiconductors, etc.). An example of a Convergence Pairtrade occurs when one stock has moved up substantially but the other has not moved. In this case, you can buy the stock that has not moved yet and sell the one that has already moved up a lot. The idea is that either the stock that has not moved may catch up, or the stock that has already moved up a lot may have a pull-back; in either case, the two stocks "converge" back to their normal relationship. If you choose the numbers of shares correctly, you can create such a Pairtrade that is market neutral and will allow you to capture the relative value between the two stocks. At Tradetrek.com, a sophisticated search engine constantly scans the entire universe of stocks and uses advanced mathematical models to identify potentially profitable Pairtrades. These trade opportunities are promptly posted (with clearly written trading rules and instructions) under Pairtrade Live Picks. (Please see figure 2 for a visual example).

Why does the Convergence Pairtrade work?

The "Market Neutral Strategies" chapter in the Tradetrek University explains in detail why the Convergence Pairtrade works. Here you will learn how to use the Pairtrade feature.

How do I access the Convergence Pairtrade Live Picks at Tradetrek.com?

Accessing the Pairtrade feature is easy. First click on the "Quantitative" category on the navigation bar as pictured in Figure 1. Then, click on the "Pairtrade Live Picks" button on the secondary navigational bar and you will arrive at the Pairtrade Live Picks. Convergence Pairtrades are listed on the left half of the screen.

Figure 1. Accessing Pairtrade Live Picks

In order to view a particular Pairtrade, please click the button and you will see the detailed Pairtrade page with the Pairtrade chart, as shown in Figure 2.

Figure 2. Convergence Pairtrade from the Pairtrade Live Picks feature

How do I read and understand the Pairtrade chart?

In figure 2, the Quote Panel shows that the Pairtrade is to long (buy) 1000 shares of CHKP and short 4106 shares of SLR. One can of course scale it up or down proportionally, e.g., long 100 shares of CHKP and short 410 shares of SLR. The "Entry" prices, 62.2 for CHKP and 23.85 for SLR, are the last prices at the time the Pairtrade was picked and they are good references if one wants to execute the Pairtrade. The amounts listed under the "Capital" heading are the buying power required to do the Pairtrade without margin. In reality, you can use the commonly available 50% margin and the actual capital required is only half of the number posted, e.g., $159,811.14/2 = $79,905.57. The other numbers should be self-explanatory.

On the Pairtrade graph the green curve that connects the blue and green dots represents the history of the profit and loss of the Pairtrade if it had been put on at the entry prices. In figure 2 it is identified as the History Curve. Over a period of two months, we compute a daily number by the following formula:

1000*(Price of CHKP - 62.2) - 4106*(Price of SLR - 23.85)

This number is the hypothetical profit or loss if we had bought 1000 shares of CHKP at $62.2 and shorted 4106 shares of SLR at $23.85 per share. It is plotted on the chart as a dot and then connected with the green curve for a better visual understanding of the Pairtrades viability. The last point represents the profit or loss now, it is plotted as the cyan colored dot and we will refer to this as the "Tracker".

If you execute the Pairtrade at the posted "Entry" prices, you are buying at the point represented by the Tracker. If the Tracker moves up, you make money and if it moves down, you lose money. The vertical gray line indicates today, as you can see the Tracker is on the line. The graph displays that the combined Pairtrade position---the portfolio of long 1000 shares of CHKP and short 4106 shares of SLR---was non-directional in the past 36 days and it oscillates up and down around the horizontal green line which represents the "mean value" that the Pairtrade portfolio tends to converge to. We can also see that the Tracker has moved up from the blue dot, or hypothetical loss. If the relationship between the two stocks does not disintegrate, it is most likely the Tracker will move up back to the green line and the trade will make money.

However, the relationship between the two stocks often breaks up and then the Tracker may drop below the red horizontal line. It is a good indication that the relationship has been broken if the Tracker drops down to the red line. At this point you should promptly cut loss by unwinding the Pairtrade: sell the long stock and buy back the short stock at a loss. The red line is therefore called the "cut-loss line." The corresponding loss is the "Cut loss limit" posted at the bottom of the Quote Panel. In this case it is -4170.

If the Tracker indeed moves up to the green line, as it should, the Pairtrade has made a profit and it is advisable to unwind the Pairtrade at this point. The green line is called the "profit target line." The corresponding profit is the "Profit Target" also posted at the bottom of the Quote Panel. In this case it is $7460.

According to historical testing, about 70% of the time the Pairtrade wins.

How do I trade stocks following the Convergence Pairtrade strategy?

Tradetrek provides instructions for how to trade each selected Pairtrade. These instructions are located just below the Quote Panel, see figure 2 above. The instructions read:

1. Always close trade if the cut-loss limit (red line) is reached.

2. Take profit promptly if the profit target is reached (green line).

3. Never let the trade turn a loser after it made a profit higher than half the profit target. Always close trade after 5 trading days.

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