ADR Arbitrage Trade

Entry Logic

• Exact Entry Trigger: The price of an American Depositary Receipt (ADR) deviates significantly from the price of the underlying foreign shares, after accounting for the exchange rate and ADR ratio.
• Confirmation: The deviation is greater than the transaction costs (commissions, currency conversion fees).
• Timeframe: Real-time, using a custom spreadsheet or software to track the spread.
• Location Context: Not applicable.
• Market Condition: Any, but volatility can create more opportunities.

Exit Logic

• Profit Target(s): The convergence of the ADR price and the underlying share price.
• Scaling Out: Not applicable.
• Trailing Stop: Not applicable. The trade is either open or closed when the arbitrage disappears.
• Signal Failure: The spread widens further.
• Opposite Signal: Not applicable.
• Time Expiration: Usually intraday, but can last a few days.
• Momentum Loss: Not applicable.

Stop Loss Structure

• Hard Stop: A predefined maximum loss based on the spread widening to a certain point.
• Soft Stop: Not applicable.
• Maximum Dollar Loss: $200 per trade.
• Maximum Percent Loss: Depends on the size of the arbitrage.
• Structural Stop: Not applicable.

Risk Management Framework

• Risk Per Trade: Very small, as this is a high-frequency, low-margin strategy.
• Maximum Daily Loss: A fixed dollar amount.
• Maximum Weekly Loss: A fixed dollar amount.
• Maximum Drawdown: Low.
• R:R Requirement: The potential profit must exceed all transaction costs.

Position Sizing Model

• Sizing Approach: Large position sizes are required to make the small price differences meaningful.
• Volatility Adjustment: Reduce size during extreme volatility.
• Conviction Sizing: Not applicable.
• Scaling In: Not applicable.
• Scaling Out: Not applicable.

Trade Filtering

• Market Conditions to Avoid: Extreme, illiquid market conditions.
• Specific Setups: Focus on the most liquid ADRs where the underlying shares are also highly liquid.
• Instrument Requirements: ADRs and their corresponding foreign shares.
• Time Restrictions: Most opportunities occur at the open of the respective markets.
• Chop/News Avoidance: News can cause the deviations that create the opportunity.

Context Framework

• Trend Direction: Not applicable.
• VWAP Relationship: Not applicable.
• MA Relationship: Not applicable.
• Range Location: Not applicable.
• Higher TF Alignment: Not applicable.

Trade Management Rules

• Breakeven: Not applicable.
• Scale Out: Not applicable.
• Add Size: Not applicable.
• Fast vs Slow Moves: The convergence can be very fast.

Time Rules

• Optimal Window: The overlap between the US market and the foreign market's trading hours.
• Times to Avoid: Illiquid, overnight hours.
• Session Notes: Requires real-time data for both markets.

Setup Classification

• A+ Criteria: A large, liquid ADR with a significant, actionable price deviation.
• A Criteria: A smaller, but still actionable, deviation.
• B Criteria: A deviation that is too small to be profitable after costs.
• C Criteria: Illiquid ADRs.

Market Selection Criteria

• Instruments: ADRs and foreign stocks.
• Volume/Liquidity: Must be very high.
• Volatility: Can be helpful, but not necessary.

Statistical Edge Metrics

• Expected Win Rate: Very high (>90%).
• Average Win Size: Very small (often less than 1%).
• Average Loss Size: Also very small.
• Profit Factor: High, but dependent on execution speed and costs.
• Expectancy: Positive, but requires scale.

Failure Conditions

• Market Conditions: A sudden currency fluctuation can erase the arbitrage profit.
• Specific Scenarios: Execution delays (slippage) can make the trade unprofitable.

Psychological Rules

• Mental Discipline: This is a purely quantitative and systematic strategy. No emotion is involved.

Advanced Components

• Market Regime Detection: Not applicable.
• Filters: Automated software is required to identify and execute these trades effectively.
• Correlation: The entire trade is based on the correlation between the ADR and the underlying.
• MTF Alignment: Not applicable.

Location

• Where Strongest: In liquid, cross-listed securities.
• Where Weakest: In illiquid securities or when transaction costs are too high.