Some good information to think about. I guess it really comes down to whatever works for the individual. Certainly cointegration seems to be the valid method from a mathematical perspective, but correlation seems to be a reasonable facsimile, going by the results of Jonny's trades. What methods do you use to identify cointegrated pairs?
I don't. I don't know how to identify cointegrated pairs, other than to see a consistent profit history and nice consistent ratio charts. That's as close to cointegrated pair finding as I get. I look for pairs with a profitable history in an industry and choose those to populate my groups. Daily I scan for pairs diverging more than 1.5 standard diviations from the mean. I don't wait for "signals" and have found many profitable trades that did not trigger a 2 SD signal. I analyze the ratio chart. When I see an interesting chart, I plug the values into a spreadsheet and check for potential profit. If the potential is greater than 2.5%, the pair is qualified. Some great looking charts (some recommended here) have a potential of only a percent or less. I don't want to tie up my money nor take risk for a low potential profit. I check for news: earnings reports and dividend x dates, other news. If all seems good, that is a pair I may trade. Walt B
Well i've just spent the last 3 days reading this thread from post one nuggets of gold EVERYWHERE. Thanks Johnny and the rest for everything I have a question for Johnny, How much emphasis can I put on winning %? Often i'll find stocks that correlate 40-50-60% however have a win ratio of 97-100% on over 12 trades! with win/loss ratio of 2+ Obviously the more supporting indicators the bigger the edge but how legit is this winning % coupled with win/loss ratio? If I were to build a universe with say 500 pairs with winning % of 95% and win/loss 2+....would I be correct in allowing for pairs with lower correlation?
Waltbx, whilst I tend to agree with you regarding your feelings towards correlation (and in fact Rob Friesen agrees with you in his manual), I really don't think you should be getting too excited about such a small sample. 66 trades is hardly a lot and its easy to be fooled by data from this few. Wait till you have a few thousand results.
Jonny, reading your journal with great interest! i'm totally new to spreads question: when you find a good opportunity, for example, a 2 standard deviation reversion from the mean, and it's a good, non-trending spread. how does this play out vs institutional players? . . . i mean does an opportunity disappear quickly because there are a lot of arbitrageur hunters out there? how quick to you have to be in taking a trade, once you've found an obvious opportunity?? i hope the answer is: relax, everyone can profit thanks! Varima
I agree with your observation. 66 trades is a very small sample. It would be much more helpful if PTF provided the profit statistics based on their trades history.
I found an excel spreadsheet that seems to look for cointegration. I did not test it as I have no plan on using it. I also found a Matlab code that I will try to use. Again, I did not test the m file yet. And I am ont sure the Johansen procedure is the right one for pairs trading! For those interested: http://www.spatial-econometrics.com/coint/johansen.m
I may be entiely wrong in this asumption but i'll go ahead. I have a feeling that the winning % is just curve fitting. You can find hundreds of pairs that are in the winning 80 to 90 percentile today and going foreward will not maitain that level of a winning percentage of the past. If you select a group of winning pairs today and go forward 6 months with the same consistancy of 80 -90% winners you may have good candidates for pair trading. Any thoughts?? cheers john