Day Trading & Forex Forum

slotcars12

hi there,

I am looking to design a pair trading strategy.
Correlation can find suitable pairs. But to be profitable I need to calculate the extent to which a pair of stocks reverts to its mean spread.

I have heard co-integration can do this. But does anyone explain to me a simple way I can do this?

Martinghoul

There's no simple way to do co-integration. Why don't you start with simple regression as a first step? The you can proceed to more complicated econometric methods. Eventually you'll get to co-integration.

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shatztrader

market models by Carol Alexander maybe of help on co-integration

GammaJammer

can you not get most of the way there by plotting a moving average of the spread, and looking for deviation from that? or am I being a retard?

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charliechan

hello slotcars -

you're in luck, as i happen to have a phd in rocket science.

why look for reversion to the mean? i have worked to some degree with spread characteristics (not pairs/stocks however). i found it was when the spread moved away from its mean that gave better opportunities. when trading reactively back, i would often get caught out as if the spread had moved significantly past say 2 sd's then this would indicate that something fundamental had changed - the old relationship was no longer there. fwiw, i think you have to avoid those tempting opportunities that appear way out of line with the mean, and trade some middle ground. finding that middle ground is where i had difficulty.

perhaps - if i have understood you - i am banging on about your reactive 'range' trading v trend following, which i may add doesnt answer your question or offer much help.

still, did i tell you i have a phd in rocket science?

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Quote:

Originally Posted by slotcars12 I need to calculate the extent to which a pair of stocks reverts to its mean spread.

Why do you think securities will revert to the mean? Does this happen seasonally? Is there any actual reason that you believe securities have to return?

Quote:

Originally Posted by charliechan I happen to have a PhD in rocket science.

Do they still pay you guys by the hour?

Quote:

why look for reversion to the mean?

Maybe he has to much time on his hands.

Quote:

I am banging on about your reactive 'range' trading v trend following?

Trend following is a viable strategy, that works well when markets seasonaly adjust. This reactive range thing can be summed up in “cut your profits short,” probably works if at all, during congestion phases.

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