Day Trading & Forex Forum

Castor

Does anyone know of way to use Metastock for pairs trading? It appears to be impossible to use a signal generated by the relationship between two securities as an order/alert for either one of them. Or am I missing something?

jsc

Pairs trading relies on tight correlation and mean deviation. Also consider Beta correlation and remember to ratio your actual trade volumes accurately. I have created a model for pairs trading in Excel which works well, however I need to set up an automatic correlation search facility to find stocks/funds with a tight correlation. One option is a basket of gold stocks and an ETF gold fund, or gold spot price. Should be possible to arbitrage trade on a greater scale using commodities and ETF's but again this is something I have not had time to look into. Possibly tradestation can be programmed to search for correlations - does anyone know?

ZEPPO

You can also read the Downloader Manual, where a section covers what you wnat to do.
It is called "New Composite" and it is found on page 42 - at least in my copy.
Hope this helps.

Eduardo

jsc

Trading two stocks in the same sector which are loosely correlated is not pairs trading. Its a completely pointless exercise. You are taking two opposing directional trades within the same sector for no reason other than the graphs look similar when overlaid and you fancy the idea of hedging your bets. Commission/spread is most likely to destroy any potential profit even with a tight stop on both trades. You may as well just trade one of the stocks short/long with a tight stop.
Do you have a formula for your correllation? How are you comparing movements? How are you calculating the deviations? What timescale are you backtesting your model over?
I could go on - let the amateurs 'pairs trade' and concentrate on creating a strategic model based on technical parameters and do not think it needs to be complex to be very effective - alternatively you will need to devote a lot of time and effort creating your own pairs trading model from scratch, and the calculations involved are horrendous.
Good Luck

Castor

Thanks, Zeppo. I have read the manual and I know about composites, but the only way I can see that you could set up a pair trading on Metastock would be if you were trading a pretty simple system based on the ratio alone. Even then, you couldn't use a signal generated by the composite as a signal for one of the two securities that go to make it up. Or am I wrong?

Castor

I don't know about Trade Station, but I do know that you can take a lot of the slog out of selecting pairs by using PairTrade Finder. You can download it from the site of the same name and try it out for 30 days. The software also gives trading signals, but you can take 'em or leave 'em. Only snag is that you may not be able to use it to correlate a commodity with a security. But if you're happy to use an ETC as a substitute for the underlying cash price it should work.

I agree with you about tight correlations, though I have also found -- maybe you have too -- that there is such a thing as too tight. Trading Royal Dutch Shell A and B, for example, I've found that, if you get a significant deviation from the ratio at the close it will often have been closed up by the market makers when they offer prices for the following day's open -- and the stretch you are left with is not enough to offer a profit that makes the trade worth the trouble.

One final point. You say "consider Beta correlation" -- in what way?

ZEPPO

I don't know - I don't pair trade, it's hard enough to get it right with one product; but I thought that was the objective of composite charts.
You could address the issue with Equis; who knows, you might even be lucky and they would do something about it.

Eduardo

jsc

Beta Correlation refers to Beta.
FTSE = 1 If a stock moves 2% for every 1% the FTSE moves then it has a Beta of 2.

You need to compensate for respective Beta in each stock when considering the number of shares to trade for each stock. You need to formulate the calculation for the two stocks beta as a ratio, therfore, you buy 1.6 shares of x for every 1 of y, in order to balance the trade correctly.
The whole setup is insanely complicated if you want to do it properly, I really would leave it alone. I had some seriously good Prop traders struggling to understand the calculations involved on my excel sheet. I will have a look at the Pair trade finder tho, thanks.
And actually, the correct opportunity only comes round about every 8 - 12 weeks, therefore you need a huge number of correlated opportunities to trade the system even once a week, and frankly I doubt they exist. This is why i have not taken it further, that and a lack of time. And no they cant be too closely correllated and really you need at least a million pounds to take advantage of the deviations which are very small. So you could use £100k and leverage it if you liked.
Basically, its a lot of effort and time to do it properly and most people who confidently tell you they 'Pairs trade' are a bunch of jokers. Generally they are the most dangerous type of trader out there - they think they know what they're doing!