How do you trade correlations?

Discussion in 'Strategy Development' started by mizhael, Mar 29, 2010.

  1. Let's say you have two assets that historically have high correlation, but recently their correlation approached 0 or even became negative.

    Any trading strategies?
  2. cvds16


    my only decent advice: don't trade correlations unless there is really something fundamental behind them. I know several guys who blew up their account thanks to so called correlations that turned out to be something else. One of them blew 15 million euro for a bank, guess what ? he got fired :D
  3. Historical correlation says nothing about the future. It is all past history. What says something about the future in probabilistic terms is patterns of correlation. From the questions you are asking, you got a long way before you can approach the subject, pls do not take it personally, it is very technical.
  4. jem


    in have not traded pairs. But, I am thinking about it as my edges have become very small.

    But what the pairs guy are telling you is that pairs may blow up going forward. So you try to guess which ones won't. The better your feel the better your chance of survival.

    The feel I wish I had is when you see a pair begin to diverge is there a look and feel to how buyout news leaks and pairs respond.

    I.e. no pullbacks - consistent bids and offers, are spikes in the option vols too late - are options too noisy to give clues.

    The best pair trading advice. Trade someone elses money. Which is probably true for all rtm strategy. People who once had a real edge kind of feel superior to those who just sell more because we are 3 stds from the mean.

    You will also that RTM guys feel so inadequate they go around saying T/A does not work and trend followers all blow up.
  5. Use a product that allows you to express a view on realized correlation... Specifics will depend on the asset/product class in question.

    As to TA, there's a whole variety of TA "methods" that are fundamentally based on mean reversion.
  6. jem


    of course... for instance bollinger band bounces at say 2sd deviations seem to used by pair traders and many t/a people.

    My rant was directed the guys who think statistics are not t/a. It was not a well written rant I apologize.
  7. dhpar


    correlations are usually traded via options (straddles), e.g. buying S&P vol vs selling individual components vols. it is also called volatility dispersion trading (try to google this term instead).

    these are advance strategies for BIG accounts only - basically only banks and HFs...
  8. dhpar


    I remember FDAX from Wilmott times....:)
  9. Well, the difference is simply the rigor and diligence of the analysis. A lot of TA is arbitrary mumbo-jumbo, whereas statistics is based on some sound mathematical concepts. Sorta like astrology and astronomy... This is my personal opinion.
    #10     Mar 29, 2010