Recent content by BigDog

I have to disagree. There are plenty of examples of pairs that continue to work. However, I do agree with you that triplets offer fresh opportunities. We also trade some of these.

You make a good point. And, indeed, one approach is to implement the strategy in a limited number of pairs in stocks you know inside out, as you suggest. My preference, on the other hand, is to implement the strategy in a larger number of pairs so that the capital allocated to any particular...

Pairs Trading = Numbers Game One of the first things you quickly come to understand in equity pairs trading is how important it is to spread your risk. The reason is obvious: stocks are subject to a multitude of risk factors – amongst them earning shocks and corporate actions -that can blow up...

I was referring to the overall portfolio, not the individual positions.

The divergences from fair value would have to be big enough to be profitable to trade. There are lots of examples of pairs that are very tightly connected as in your example - so much so, in fact, that tiny divergences are very statistically significant (Series A and B in the same stock might...

The problem with correlation is that it can easily arise from two completely unrelated random processes (including stock prices) just by random chance. So things look related when in fact they are not. There are lots of stupid examples of this, like tea consumption in Japan vs steel demand in...

Yes you have described the idea behind the Kalman Filter very well. 1. In theory I suppose you could use a KF to model the link between a stock and its derivatives (including options). In which case you are using KF to estimate the option delta ( a more complex model might also account for...

1. Actually, no. It would be highly unusual to find a pair for which beta is constant. Instead, the model assumes that beta(t) changes over time dynamically. One then uses a moving (or expanding) window of observations to reestimate beta over time (regression/residual model), or using a...

I don't recall reading anything about using for correlation estimation. It's an interesting idea. But the KF isn't really a prediction tool, as such. So it isn't like using a GARCH model to forecast volatility for option pricing, for example. What KF does is provide a way to estimate the true...

We can take market data from the api, or from another source.

Its dollar neutral - $100 long, $100 short

2:1

It's all handled through the C++ api (or C# or Python as required). For pairs we can do market or resting orders (crossing the spread on the second leg when when the first resting order is filled). For triplets we just use market orders and pay the spread on all three legs.

Hi Robert, So this version of the strategy trades intraday. Hold times varying from minutes to days, depending on the pair. So there is overnight risk. But margin utilization is very efficient due to dollar neutrality of the portfolio. For purely intraday trading our focus is more on HFT...