Seeking Alpha

How To Gain An Advantage With Parallel Trading

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Includes: AAPL, CAT, F, GM, KODK
by: The Mad Hedge Fund Trader
Summary

Parallel trading is an incredibly useful trading strategy.

Some parallel trades break can down and die.

When Parallel Trading Chain disappears, many more replace it.

One of the most fascinating things I learned when I first joined the equity trading desk at Morgan Stanley during the early 1980s was how to parallel trade.

A customer order would come in to buy a million shares of General Motors (NYSE:GM) and what did the in-house proprietary trading book do immediately? It loaded the boat with the shares of Ford Motors (NYSE:F).

When I asked about this tactic, I was taken away to a quiet corner of the office and read the riot act.

"This is how you legally front run a customer," I was told.

Buy GM in front of a customer order, and you will find yourself in Sing Sing shortly.

Ford, Toyota (TM), Nissan (OTCPK:NSANY), Daimler Benz (OTCPK:DDAIF), BMW (OTCPK:BMWYY), or Volkswagen (OTCPK:VWAPY), are no problem.

The logic here was very simple.

Perhaps the client completed an exhaustive piece of research concluding that GM earnings were about to rise.

Or maybe a client old boy network picked up some valuable insider information.

GM doesn't do business in isolation. It has tens of thousands of parts suppliers for a start. While whatever is good for GM is good for America, it is GREAT for the auto industry.

So through buying F on the back of a GM might not only match the GM share performance, it might even exceed it.

This is known as a Primary Parallel Trade.

This understanding led me on a lifelong quest to understand Cross Asset Class Correlations, which continues to this day.

Whenever you buy one thing, you buy another related thing as well, which might do considerably better.

I eventually made friends with a senior trader at Salomon Brothers while they were attempting to recruit me to run their Japanese desk.

I asked if this kind of legal front running happened on their desk.
"Absolutely," he responded. But he then took Cross Asset Class Correlations to a whole new level for me.

Not only did Salomon's buy F in that situation, they also bought palladium (PALL).

I was puzzled. Why palladium?

Lots of car sales, which the GM buying implied, ALSO meant lots of palladium buying.

And here's the sweetener.

Palladium trading is relatively illiquid.

Because palladium is the principal metal used in catalytic converters, which remove toxic emissions from car exhaust, and have been required for every U.S. manufactured car since 1975.

So, if you catch a surge in the price of this white metal, you would earn a multiple of what you would make on your parallel F trade.

This is known in the trade as a Secondary Parallel Trade.

A few months later, Morgan Stanley sent me to an investment conference to represent the firm.

I was having lunch with a trader at Goldman Sachs (GS) who would later become a famous hedge fund manager and asked him about the GM-F-PALL trade.

He said I would be an IDIOT not to take advantage of such correlations. Then he one-upped me.

You can do a Tertiary Parallel Trade here through buying mining equipment companies such as Caterpillar (CAT), Cummins (CMI), and Komatsu (OTCPK:KMTUY).

Since this guy was one of the smartest traders I ever ran into, I asked him if there was such a thing as a Quaternary Parallel Trade.

He answered "Absolutely," as was his way.

But the first thing he always did when searching for Quaternary Parallel Trades would be to buy the country ETF for the world's largest supplier of the commodity in question.

In the case of palladium, that would be Russia (RSX) followed by South Africa (EZA), which together account for 74% of the world's total production.

Since then, I have discovered hundreds of what I can Parallel Trading Chains, and have been actively making money off of them. So have you, you just haven't realized it yet.

I could go on and on.

Do this for decades as I have and you learn that some parallel trades break down and die. The cross relationships no longer function.

The best example I can think of is the photography/silver connection. When the photography business was booming, silver prices rose smartly.

Digital photography wiped out this trade, and silver-based film development is still only used by a handful of professionals and hobbyists.

Oh, and Eastman Kodak (KODK) went bankrupt in 2012.

However, it seems that whenever one Parallel Trading Chain disappears, many more replace it.

You could build chains a mile long simply based on how well Apple (AAPL) is doing.

Suffice it to say that parallel trading is an incredibly useful trading strategy. Ignore it at your peril.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.