Pairs Trading UK & US Stocks Journal

That's an interesting pair - looks like only 40% correlation prior to November...

How do you protect yourself against a situation where the sector takes a nosedive and all players in the sector appear to be more correlated ?

Also - the big bear market we are currently in - most instruments are going down but that doesn't mean they are correlated per se - just that everything is going down.

I'd have thought that a strategy like this would be better in a non-trending market. How do you distinguish between truly correlated instruments and those simply moving with the market trend ?

Yes thats a good point and its not something I fuss about too much, if stocks are moving with the market then thats good because we will achieve market neutral so its not a bad thing should stock be correlated to a sector which is correlated to the general market. Most importantly we rely on fundamentals to prove there is real correlation as there are many correlated pairs from different industries, for instance ive seen a trucking stock with 95% correlation to a clothing stock, I wouldn't trade this pair as different industry-macro factors affect each business, so as long as our pairs are in the same industry we only use the technical correlation reading to confirm its relationship.

Sold BPZ - 3.65

Covered PDC - 4.15

Opened new trade in US Oil & Gas Drilling Industry

Long Entry PDC - 3.85

Short Entry RDC - 12.22

Entered new trade in US Gold Industry, Im finding most of my UK pairs are decreasing in correlation at the moment for those wondering why I haven't taken many UK trades.

Long Entry ANV - 4.00

Short Entry GRS - 7.76

S77:

I am surprised with your latest pair. The correlation graph on PTF shows that correlation has peaked and is now declining. Your comments please.

Lado, the correlation chart doesn't have to be making all time highs, a little dip is ok, its the most likely the divergence that caused this little dip, whats important is the latest reading is higher than the 1st reading on the chart so there is a long term uptrend, if there was a strong short term trend down I wouldn't take the trade.

From what I have read on a similar thread at elitetrader.com, the experienced traders say that correlation has to be trending upward for a pair to be worthy of consideration. For this most recent pair, correlation has peaked and is heading downward. May be others get it but I don't.

Lado