By analyzing historical price movement of two similar financial instruments, you may discover a trade opportunity known as an arbitrage or pairs relationship. Though these two financial instruments may appear to move together, there are sometimes differences in price due to market inconsistencies. By taking advantage of these inconsistencies, arbitrage trade opportunities may appear.
Find Price Movement Correlations through Backtesting
Backtesting a Crude Oil (CL) & Brent Crude (B) futures trading strategy on a charting platform is an ideal first step to identify correlations in price movement. As an example, during the last year, there were several periods when Crude Oil had ‘exaggerated’ or greater price moves when compared to Brent Crude.
Looking at the chart below:
Executing a Futures Arbitrage Trade Opportunity
There are two potential trades you could backtest with indicators and possibly implement based off this correlation:
- Simultaneously sell Crude Oil and buy Brent Crude into bearish moves (or vice versa into bullish moves) with the objective of potentially capitalizing on the difference in price
- Take advantage of the time zone difference between London (where Brent is primarily traded) and New York (where crude oil is primarily traded) by using Brent Crude as a lead day trading indicator for a move in Crude Oil
Before you enter a pairs trade, you should plan your exit. There are many ways in which exiting the trade can be methodically achieved. One example is programming opposite (buy and sell) automated trading orders for Crude Oil and Brent Crude on your online trading platform to execute once predetermined price levels occur. The goal of programming two separate buy and two separate sell stop exit orders is to limit potential loss and protect potential profit.
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