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Can the little investor keep the 'big guys' from stealing their money? Is it safe for the average investor?
In a bear market that often runs sideways many 'big money'investors are using a tried and true, well known, often used stratigy. If you don't know what it is and how to use it ... how are your protecting your money ?... Your piece of the wealth affect has probably been stolen from you by now and you don't know why. Remember ... some one loses when some one wins. For every dollar you have lost ... someone has it in their pocket. If you lost sight of this little fact then perhaps becoming fully liquid for the next couple of years may be the best strategy for you or you may want to learn to hedge so that you can still play the game ... If you don't know the rules have changed can you afford to continue to play the game? Is it time to bring in the stock pickers and learn to buffer your losses? With bull market strategies and firm convictions becoming casualties of this stalled, often rocky bear market, some on Wall Street are reviving a strategy intended to capitalize on difficult conditions. This approach, called pair trading, is essentially an exercise in extreme stock-picking that seeks to make an investors portfolio indifferent to which way the overall market goes � or whether it moves at all. A pair trade simply means to buy a stock that is thought to be undervalued while, at the same time selling short an equal dollar amount of a similar or related stock, typically of a competitor in the same sector, that appears overvalued. The short position is a wager that the stock price will decline, thereby reducing investor risk by protecting against a market downturn. Offsetting it by owning a stock, the long side of the equation, makes an investor neutral to the market, and, depending on the picks, more or less impervious to the vicissitudes of a particular industry. Like puts and calls what's left are bets on individual stocks. For example ... a play that would have worked well several months ago would have been ... Safeway long ... Albertsons short. If the stock picks are on the mark, an investor can make money on both the long and short sides. The strategy creates a buffer that would nullify the direction of the the overall market. According to Christopher J. Wolfe, an equity strategist for private clients at J. P. Morgan Chase, "It's actually an all-weather strategy, but it makes more sense in a sideways market. It works well with companies with similar products or end markets whose stocks are closely correlated, but where there is a valuation disparity." The strategy can be used just as well in volitle, gyrating markets, but with great care. "Pair trades also are a way to play volatility," Mr. Wolfe said. That is because any news or development that strengthens the competitive position of one company versus the other, like a new product, will have a greater impact on the respective stock prices in a volatile market. Remember ... what is in motion ... tends to stay in motion. "The correlations become less stable," he said. If you are unswervingly bullish or bearish you are probably better off simply owning stocks or shorting them, without any hedge. Clark B. Winter Jr., chief investment strategist for Citigroup's private banking division believes, "You don't hear much about pair trades in bull or bear markets." But says he thinks the current investment climate makes this strategy attractive for the bank's clients. He said Citigroup looks for hedge fund managers "with the ability to identify pair trades as part of their ongoing strategy." Catherine Jackson, director of research at LJH Global Investments, a firm in Naples, Fla., that helps institutions and wealthy individuals assemble hedge fund portfolios, said pair trading was gaining appeal with managers investing in Europe. According to Ms. Jackson, "Everybody's using the strategy now. "What else can you do in a trendless market?" Perhaps by now you are getting the picture of what the 'big boys' are doing and how dramaticly it has affected your little portfolio. Yep, they are playing with your money. If you do not know what a short sell is ... here is how it works ... An investor sells borrowed shares of a stock and hopes that the price will drop so he can eventually return them to the lender at a lower cost and he pockets the difference. If it rises, the investor loses money. This can be a very dangerous play because theoretically there is an unlimited downside loss to the investor. As an example ... say an investor buys General Motors and short sells Ford Motor, which of these companies has a higher price-to-earnings (P/E) ratio? Experts suggest caution in pair trading. Your capital is the most precious possession you have ... and your job is to protect it ... with out capital ... there is no trading ... Pair trading requies good research and knowledge of the markets. Like any form of active management, there are risks. The investor is choosing individual stocks rather than relying on a broader, indexed approach that provides average market returns. In fact, pair trades can increase risk, as well as reduce it. If you select the wrong stocks, you can lose money on both sides of the transaction. John Moon, manager of $1 billion in emerging-markets hedge funds at Oak Tree Capital, says, "You need to identify price anomalies plus make a call on the fundamentals. It requires intensive research." His view suggests that pair trades work best in volatile industries, like technology and telecommunications, because there is more opportunity to take advantage of stock price divergences. He says he is now shorting the stocks of several American manufacturers that work on contracts, because of their high valuations and vulnerability to a prolonged economic slump, but would not disclose any company names. His pairing includes long shares of certain Asian companies in the same industry, like Elec & Eltek, which he believes are more reasonably valued and likely to rise more when the sector improves. Robert Jain, head of global portfolio and program trading at Credit Suisse First Boston, regularly uses pair trades on behalf of the firm's clients. He said he thought the strategy's appeal was growing. He says, "People are realizing that they can't rely on the market's continuing to go up." But he recommends that clients buy a stock and short a related exchange-traded fund, a mutual-fund-like product that trades like a stock, i.e., Diamonds, QQQ, etc., or, they may buy the E.T.F. and short the stock. He believes that ... "Buying one stock and shorting another doesn't reduce your risk that much. You're still assuming a lot of company-specific risk." He is now recommending a pair trade that involves buying either the El Paso Corporation or Anadarko Petroleum, both energy companies that carry his firm's top rating, and selling short either the iShares Dow Jones U.S. Energy Sector Index fund or the Energy Select Sector SPDR, a basket of energy stocks traded on the American Stock Exchange that has similar investment characteristics but is more actively traded. Mr. Jain has also recommended buying either of two health care stocks, Johnson & Johnson or Pharmacia, and shorting the iShares Dow Jones U.S. Healthcare Sector Index fund. Exchange-traded funds have an advantage beyond greater diversification. Unlike stocks, they are not subject to the downtick rule, which prohibits shorting a stock at a lower price than the preceding sale which prevents negative sentiment from snowballing. "If you're trying to put on a trade of two stocks, there's a risk that you can execute one side and not another, because of the short-sale rule," Mr. Jain said. At J. P. Morgan Chase, Mr. Wolfe is recommending several stock-for- stock pair trades to the firm's private clients. He advises investors to buy shares of Pfizer, the pharmaceutical company, and short the shares of its rival, Merck. He said that despite comparable valuations, Pfizer had fewer major drugs about to lose patent protection. He also continues to like a trade pairing in a long position in Sun Microsystems with a short position in EMC. The companies have similar markets in data storage, Mr. Wolfe said, but adds that EMC was more vulnerable to weakness in this sector because of its still-high price-to-earnings multiple. But Mr. Wolfe added this caution about pair trading: "This is a trading strategy, not an investing strategy," he said. "You should view it as a side bet." With all these parameters you can see that the strategy is not simple or safe and that you can put your money ... your portfolio at great risk, but i am sure you can also see how it adds to the volitility of the markets and to the weekly short sells into ralleys we have been seeing. It seems to me that we are not only in a bear market but also in a bull/bear cycle heavily laced with pair trading. If you are a novice trader remember ... cash ... money market funds ... gold ... can be a good thing to protect what you have if you can not play with the 'big boys', and most of us can't. Remember, always, always ... always ... do your own due diligence ... check with your broker before you make any investment decision ... and learn, learn ... learn.
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Copyright � 2001�� Cassie �� All rights reserved. 
 ~cassie~ 
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