Paul Cretien illustrates how to execute pairs trades in FAANG stocks.
FAANG is an acronym for the market's five most popular and best-performing technology sector stocks, according to Investopedia. It includes: Facebook (FB), Apple (AAPL), Amazon (AMZN), Netflix (NFLX) and Google (GOOG).
The original acronym was FANG, then Apple was added to the group. They are viewed somewhat separately for the rest of the tech sector due to their relative youth and disruptive nature. The group itself provides numerous pairs trading opportunities that should yield profitable trades in 2019. Each stock’s individual performance for 2018 is shown on the chart below.
As you can see, there is a general correlation among the stocks though their performance varies widely. The best pair trading opportunity throughout 2018 and heading into 2019 combined Amazon with Netflix, as their movement was highly correlated, but with enough difference in relative price volatility to create profitable trades.
Volatility differences provide the means for success in pairs trading, as the more stable member of the pair provides a landing place for the volatile member following each spike or dip in its price. For example, from July 8 through Aug. 20, Netflix declined while Amazon increased at a slow, steady pace. Netflix grew at a much sharper pace in the first half of the year until its June peak, which provides a reversion to the mean trade with Amazon. We would look for similar profitable price changes between Netflix and Amazon in 2019.
Other pairs that may be spotted on “FAANG Stocks in 2018” include Apple and Amazon, Facebook and Google, Google and Apple, Apple and Amazon, Apple and Netflix and Amazon and Netflix. Of these pairs, the only one whose two members are too closely paired to be traded is Facebook and Google. For the others, an example trade is shown for each pair, with the more stable member listed first and bought. The more volatile stock is listed second and is sold at the beginning of the trade. The position is exited on the second date.
Of course, the example trades were made easier by selecting dates on the chart. In the real world, it will be up to the trader to follow the progress of the five FAANG stocks to see good pairs trading opportunities. The process is one of looking for a volatile stock that is currently highly-priced relative to a less volatile stock, where both members of the pair have been observed over a period of time long enough for the trader to be acquainted with their typical price movements (or by using the lazy way with trades based on a long-term chart).
Notice that volatility is relative and a stock that is considered the more volatile member of one pair may be considered the stable member when paired with a second stock or at a different date.
Well-considered pairs trades should result in profitable opportunities with only low to moderate risk.
