Risk Disclosure Statement

1. General Trading Risks

1.1 Risk of Loss

You can lose money trading. There is no guarantee of profit, and losses can exceed your initial investment, especially when using leverage or margin.

1.2 Past Performance

Past performance is not indicative of future results. Historical backtests, even if profitable, do not guarantee future profitability. Market conditions change, and strategies that worked in the past may fail in the future.

1.3 Volatility

Securities prices can be extremely volatile. Rapid price movements can result in significant gains or losses in short periods. Volatility is especially pronounced during market stress, news events, and low liquidity periods.

2. Pairs Trading Specific Risks

2.1 Cointegration Breakdown

Pairs trading relies on the assumption that two historically correlated assets will continue to move together. This relationship (cointegration) can break down permanently due to:

• Mergers, acquisitions, or corporate restructuring
• Changes in business models or management
• Sector rotation or market regime changes
• Regulatory changes affecting one security differently

When cointegration breaks down, you can experience losses on both legs of the trade simultaneously.

2.2 Correlation Risk

Even cointegrated pairs can temporarily move in the same direction, especially during:

• Market crashes (correlations spike to 1.0)
• Industry-specific shocks
• Liquidity crises

This defeats the "market-neutral" advantage and can result in losses on both long and short positions.

2.3 Mean Reversion Timing

"Markets can remain irrational longer than you can remain solvent." Even if a pair will eventually revert to the mean, it may take longer than expected, tying up capital and potentially triggering margin calls.

2.4 Execution and Slippage

Pairs trades require simultaneous execution of two legs (long and short). Challenges include:

• Slippage: Actual execution prices differ from expected prices
• Timing delays: One leg executes before the other, creating temporary imbalance
• Partial fills: Only part of your order executes, leaving position unhedged
• Spread costs: Bid-ask spreads on both legs reduce profitability

3. Leverage and Margin Risks

3.1 Amplified Losses

Leverage magnifies both gains and losses. A 2x leveraged position means a 10% adverse move results in a 20% loss to your capital.

3.2 Margin Calls

If losses exceed available margin, your broker can:

• Issue a margin call requiring additional funds
• Liquidate your positions without notice
• Close positions at unfavorable prices

3.3 Interest Costs

Margin loans accrue interest daily. During extended holding periods, interest costs can erode or eliminate profits.

4. Short Selling Risks

4.1 Unlimited Loss Potential

Short positions have theoretically unlimited loss potential. While a long position can only lose 100% (stock goes to zero), a short position can lose multiples of the initial investment if the stock price rises significantly.

4.2 Hard-to-Borrow Fees

Some stocks are expensive to borrow for short selling:

• Fees can range from 5% to over 100% annually
• Fees are charged daily and can change suddenly
• High borrow costs can make otherwise profitable trades unprofitable

4.3 Short Squeezes

When many traders are short a stock and the price rises rapidly, forced covering can drive prices even higher, resulting in catastrophic losses. Recent examples include GameStop (2021) and various "meme stocks."

4.4 Dividend Risk

When you short a stock, you must pay any dividends to the lender. Unexpected special dividends can result in significant costs.

4.5 Recall Risk

Your broker can recall shares you've borrowed for short selling at any time, forcing you to close your position, potentially at an unfavorable price.

5. Liquidity Risks

5.1 Inability to Exit

Low liquidity can make it difficult or impossible to exit positions at desired prices, especially in:

• Small-cap or micro-cap stocks
• After-hours or pre-market trading
• During market stress or halts

5.2 Wide Spreads

Illiquid securities often have wide bid-ask spreads, increasing transaction costs and reducing profitability.

6. Market and Systemic Risks

6.1 Black Swan Events

Rare, unpredictable events can cause extreme market disruptions:

• Financial crises (2008, COVID-19 in 2020)
• Geopolitical shocks (wars, terrorist attacks)
• Natural disasters
• Technology failures or cyber attacks

6.2 Regime Changes

Market structure and behavior can change fundamentally. Strategies optimized for one regime (e.g., low volatility, low correlation) may fail catastrophically in another regime (high volatility, high correlation).

7. Regulatory and Tax Risks

7.1 Pattern Day Trader Rules

If you execute 4 or more day trades within 5 business days, you're classified as a Pattern Day Trader (PDT) and must maintain a minimum $25,000 account balance. Violations can result in account restrictions.

7.2 Short Selling Restrictions

Regulators can impose short selling restrictions during market stress (e.g., circuit breakers, bans on specific stocks).

7.3 Tax Complexity

Pairs trading creates complex tax situations:

• Short-term vs. long-term capital gains treatment
• Wash sale rules (buying back similar securities within 30 days)
• Mark-to-market accounting elections for active traders

Consult a tax professional to understand implications.

8. Technology and Data Risks

8.1 Data Errors

Market data can contain errors from providers. Trading based on incorrect data can result in losses.

8.2 System Failures

Technology failures can prevent you from managing positions:

• Broker platform outages
• Internet connectivity issues
• Device failures

9. Suitability Considerations

Pairs trading may NOT be suitable if you:

• Have limited trading experience
• Cannot afford to lose your investment capital
• Do not have time to monitor positions daily
• Do not understand statistical concepts (cointegration, correlation)
• Have a low risk tolerance
• Are investing for short-term needs (pairs trades can take weeks/months to play out)

10. Risk Management Recommendations

If you choose to engage in pairs trading, consider:

• Position sizing: Risk only 1-2% of capital per trade
• Stop losses: Define maximum acceptable loss before entering
• Diversification: Don't concentrate in one sector or pair
• Paper trading: Practice with hypothetical money first
• Education: Thoroughly understand statistical arbitrage before risking capital
• Professional advice: Consult licensed financial advisors

Acknowledgment

By using PairSync, you acknowledge that:

• You have read and understood this Risk Disclosure Statement
• You understand the substantial risks involved in pairs trading
• You accept full responsibility for any trading decisions you make
• You will not hold PairSync liable for any losses
• You will consult professionals before risking capital

Questions? Contact us at mark@pair-sync.com