Sure this is a reasonable way to trade. And it is "arbitrage", but it is important to note that even things that are called arbitrage in the literature, are stat arb, not pure arb. You have to remember the two reasons people are attracted by relative value trading, which is a kind of "arbitrage" [or is the other way around?] 1) There is a natural built in cointegration of the legs so powerful statistical analysis can be done without fooling yourself. 2) There is a built in reduction of risk so that repeated application of sized bets can be attempted without risk of ruin, thereby providing real income so that trading becomes like a business instead of some spectrum of gambling. It is 2 that is hard because if it is truly an arb, you are competing with very sophisticated players in the same space. If the tier 1 players aren't there, then the "arb" is risky. Retail traders gamble. Institutions run a business by reducing gambling to its theoretical minimum.
I don't trade exactly this strategy. But everything that I do [for now] is relative value. It is important to remember that you don't have to take the auto hedge. You can just trade one side of the leg if you can tell that is the one that is likely to come into convergence. Hard, very hard to do. But for the retail trader reducing commissions is critical when you are paying $x.xx a side per leg. Too many legs and you will have a beautiful "arb" with little risk that after commissions and slippage - you lose. Retail traders have it so hard it is almost impossible.
Nitro> what do you think the minimum trade size has to be, to be able to be profitable? What would the maximum commission have to be? Can't you lower the spread cost by legging in through limit orders Btw, thanks for your thoughts.
I assume you mean in general and not on the trade you linked to in the original post since we don't know if that strategy has edge. But in general, look, trading is like any other business. It has a column for expenditures, and a column for revenue. So calculate what it costs you to do business. Comissions, Internet access, computer equipment, electricity, etc. The one mistake people make in this case is opportunity costs. If you are sitting in front of a computer breaking even from trading, then you are actually losing money since, assuming you are still of working age, you could be making $x/Hr risk free by just working and getting a paycheck at Starbucks or Uber. So at least, since everyone is able to make minimum wage which is about $15,000/Year, that is what you need to take home approximately after expenses if you truly want financial freedom from a paycheck. Then you pay taxes. This is another mistake that people make, assuming that just because limit orders are possible, that you will get a fill. Momentum systems use market orders and rarely use limit orders. Mean reverting systems can use limit orders, but often at least one leg is a market order. When you are computing your edge, be a little pessimistic on slippage. If it turns out you do better, bonus! If not, it won't be a surprise. YW.
Does this even work on consumable commodities? I mean, the physical supply/demand is highly subject to what time of the year we're in... mean reverting doesn't make sense in those calendar spreads...
JackRab> Good question. Since 5 minute charts were used, I was under the impression it was a short term strategy, lasting a couple of days tops. But I may be wrong. If it is indeed a strategy that will have you in trades for months, the seasonal effect will have to be considered indeed.