A Classic Pairs Trade

“Wise men say, and not without reason, that whoever wished to foresee the future might consult the past.” – Machiavelli

In recent Weekly Market Calls, we’ve talked about the power of objectively identifying the most similar historical instances of current market or price trends to have an objective gauge for the range of forward outcomes.  Having this historical backdrop as an input for investment and trade decisions can bolster the risk profile, have great impact on trade timing and generate new ideas in the short and long term.

The power in our Predictive Analytics engine doesn’t just reside in the speed (seconds) and accuracy (statistically driven) in which we capture a current price trend to identify the most similar historical instances.  It also allows investors to take a basket of securities they follow and to automatically be alerted to the most positive and negative forward projections to trigger investment opportunities across multiple time horizons.  By focusing on the most compelling positive and negative projections in a watchlist, or the tails so to speak, that leads to another great use case.  A classic hedge.

We loaded up all Energy stocks above $300 Million, and ran them through EidoSearch to identify the most positive and negative 1 month projections based on the average forward return of the historical instances of the current pattern.  We then scanned these projections for their risk profiles, and honed in on the most positive projections with limited downside historically (our Long candidates), and the most negative projections with limited upside historically (our Short candidates).  We ended up with two small cap stocks in Endeavour International Corp and EXCO Resources.

Endeavour International Corp and EXCO are both Oil & Gas exploration and development companies.  Endeavour’s stock is down 48% since the end of January, and was down big last week after missing earnings expectations by a wide margin.  EXCO is down 40% since last August and is about flat YTD.  Although both are depressed recently, based on our historical analysis of the current price trends we’re projecting one of the stocks to rebound and one to continue to lag.  Our pairs trade is best displayed through the charts below:

6 month price chart for Endeavour International Corp. (Our Long)

The chart below shows the 1 month forward returns for the 56 most similar instances of this 6 month price pattern in Energy stocks historically.  The stock is up 82.1% of the time, and the average return for all historical instances is 4.5%.  For the risk profile, you’ll see there are 15 historical instances that gain over 10% in the next one month historically, and only one below a 10% loss, Clean Energy Fuels Corporation which dropped -58% in October 2008.

6 month price chart for EXCO Resources, Inc. (Our Short)

The chart below shows the 1 month forward returns for the 55 most similar instances of this 6 month price pattern in Energy stocks historically.  The stock is up only 21.8% of the time, and the average return for all historical instances is -12.9%.  For the risk profile, 15 of the historical instances are down -20% or more in the next one month historically, and only two have gains above 20%.