aha. and what does "institutional" mean - you do not know, since someone in the backoffice is doing that, or you do not want to tell, because you are doing trades with brokers that let you trade some issues for free if you do enough volume?
"Institutional" means I clear a large bank directly, it's cheaper than IB, and I am under an agreement not to name names or rates. But the real point is that intraday pairs trading is profitable on a consistent basis - providing your execution costs are reasonable. If you do this on an intraday basis, you're going to generate alot of volume for modest gains. But that's the whole point. To consistently generate income. Slow and steady wins the race. Not glamorous, but effective. I mean, that's what we all want. To generate enough income to trade for a living and support ourselves (and for me a family). I can't sit there and suffer through huge flat-price P&L fluctuations during the course of a business day. Don't have the guts for it.
bone see your point on rates and respect your point - though you are on an anonymous internet board. we are currently testing an intraday pairs strategy and start feeling good with the test results. and, as you say, execution cost is key in high frequency trading. i always wondered about the correlation of fnm-fre on five minute data. must come from somehwere. styles like yours will answer that. peace
There's only one way to find out - to trade it. You can pencil-whip it to death - I'm good at it, an engineer by training. But you have to get your nose dirty to really see if it pans out. Just trade them and try to build up some capital. Once you establish a volume pattern, you should be able to shop rates.
My experience (somewhat limited) is that slippage is far more significant in pairs trading than transaction costs, particularly when you exit.
To jrweiner and other, As you pointed out, slippage can be significant. I have two questions: 1. Under what size of the trade can the slippage be insignificant? 2. How to deal with the slippage? I am think about using limit order and choose a most liquid time. Thanks.
I have read articles and talk to traders about the proper way to set up the hedge on a pair trade. When it comes to stocks that are part of a takeover it is simple but how about correlated pairs such as KO/PEP Home depot /Lowes or even SPY / QQQ. I know some traders use $ equivalency method so if SPyis $100 and QQQ is 40 they would buy 100 QQQ and sell 40 SPY since both are $ equal i.e. $4000. Does that make sense? should'nt the primary consideration be the volatility or true range of the 2 instruments? In my example above if one were to set up SPY/QQQ pair at 40% and if both have $1 range for 30 minutes, then it would be an incorrect hedge-exposing trader to a larger PnL due to the fact that QQQ might be 40% the price of SPy but have shown $1 range for the past x minutes? Can anyone suggest a way to hedge such intruments>? Thanks
GATrader, The first method that you suggest is probably the most common, but I feel more strongly about making a volatility match. Of course, the volatility sample and history window should match your trading timeframe. I trade pairs very short term. Clearly, any dollar balancing or volatility matching is based on some recent historical average or spot calculation. Will the volatilities from the last two weeks hold up in this next hour? I doubt it will hold up exactly, especially in longer timeframes, as volatilities tend to cycle. In fact, if I get these things perfectly hedged for that given time period, I'll go broke paying commissions on flat trades. So, it's my opinion, that some uncertainty or slop is necessary in sizing these pairs. For my purposes, I get my answers by backtesting the combinations to verify that it has actually worked in the past. That helps me arrive at my final sizing. Sometimes other factors come into consideration, such as....I don't do odd lots, so using your QQQ:SPY example above, I'd be limited to a 500:200 ratio as a minimum. Based on risk evaluation of this pair, let's say that I'd want to max out at 4 units (buy or sell this thing 4 times if it moves against me). I may consider a 2000:800 share position unacceptable, so I'd look at alternatives. I'd test a 200:100 ratio, 300:200, etc. Oftentimes, these unlikely sizes will perform more favorably. If you don't have access to backtesting software like Tradestation or WealthLab, I'd consider getting it and learning how to use it. Yes, some may find that a lot of work, but the rewards are well worth the effort. For anyone that's considering pair trading, this world of statistical arbitrage is full of very sophisticated traders. Trading in this niche is not going to become simpler, and going in without the proper tools will be like using a hammer and chisel when your competition is using laser cutters.