Buy This and Short That

Here’s me thinking out loud again.  I thought I’d share you my version of what people on iBC refer to as the “pair trade.”  The idea is to make a trade on both sides of a sector, or buy one stock and short another stock that is related.  We’ve kind of abused this and just went ahead and used “technicals” to figure out our pair trade, which basically means you buy and sell two stocks with two similar technical setups.   Remember now, you don’t always have to go 50/50 on a trade.  I use the term “bias” many times to show if you are going to invest more on one side than the other- kind of like betting on the roulette, though I’ve never done that.  I figure, I’d rather trust my money to a Company rather than a rolling random ball.  Why does this method work?  Well, let’s use some simple probability.  Ignore everything you know about a Company (which is absurd, I know, but probability requires you to make some allowances).  Now all we have is a stock that can go either up or down.  “Hey, that’s 50/50!”  … um, well, yes and no.  Yes, there are only two directions, but choosing a side is not that simple.  The law of large numbers shows that the more bets or guesses you make, you’ll get closer to 50% which basically means, you break even, well actually you lost because you wasted your time.  So yeah, viewing a stock as 50/50 pretty much gets you no where.  BUT if you bet on both sides, well then you win every time, but wait, that sucks too because that also leaves you at break even.  So, let’s add some variables in there since we are talking stocks…  let’s take Stock A bet for that, and now let’s take another stock, Stock B and bet against that.  Now you have 4 directions: up down up down.  However, this is where human intuition is our advantage, and where human thought kicks probabilities butt.  Instead of choosing Stock A and B blindly,  make sure you learn a little about A and B, and you bet for the “better” one, and you bet against the uglier one.  This will only work though if you give both time, to let the fruits of their labor manifest itself.  And this will only work if you pick wisely and not try to let “technicals” mess with your research.  You see, for every 1 super good awesome spectacular brilliant company, you will have 20 horrible companies, and 100 wannabe companies that are only there for the thrill (to hitch a ride).  It’s very important to remember though that while that 1 company is doing amazing stuff at it’s peak, ALL the other crap does good too.  Some do good for a few months, some a few years, but you know they are whack because they don’t earn anything, people in the community/sector hate the product, or its too hard to find out about the Company because they hide everything.  Well there you go, this is where due diligence, human intuition, and common sense gives you an unfair edge against the others… we bet for the Company that leads, while shorting the companies that you know are doing everything wrong.  Maybe the bad Company won’t crumble as soon as you want, or maybe the great company looks flat.  But patience will reward you (and this is why I’m a fan of Fundamental research).  I strongly believe we are at a point in time in the market where both awesome and dodo companies have risen up to amazing levels!  So now would be a good time to think about some long-term “pair-investments” in your IRA, or in your kids college fund.

Here’s a list to get you started.  Again, these have quite long holding periods:

Hot coffee, hot coco …
Buy-       GMCR
Short-    CBOU

Sun shines here, not here…
Buy-  FSLR
Short-  YGE

Dress for class, not for trend…
Buy- GES
Short- TRLG

Everyone loves, versus everyone hates…
Buy-  AMZN
Short-  OSTK

Be a little creative in your pair trade!  It doesn’t always have to be sector related, in can be a play on trends…
No matter what, Americans will be fat and gravitate toward fat (more mass?)…
Buy-  Buffalo Wild Wings [[BWLD]] Short-  [[LULU]]

Go with those who do, not those who dream…
Buy – Apple Inc. [[AAPL]] Short –  iRobot Corporation [[IRBT]]

Robin Hood wins…
Short- [[M]] Buy- Ross Stores, Inc. [[ROST]]

Try it out and find some Company pair-investments for yourself.  It’s a good exercise.  Even if you don’t make both trades, then at least you can see how simple it is for a winning company to keep winning, and a losing company to keep losing, and when you place your chips on both sides, you’re betting on the two highest chances while at the same time spreading out risk.  The sooner you realize this, the better your investing will be.

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