Pairs Trading Strategy Model

Just to add some critical analysis the Louis financial product...

When I was slaving away on my Computer Science degree in the early 80s...
"Data mining" was a ** pejorative term ** describing a misuse of statistics...
To dredge up meaningless patterns from mountains of data.

Today... according to Wikipedia...
The terms used for this fallacious methodology is "data dredging" and "data fishing".

When I read the Louis sales pitch...
Scanning 180,000 stocks to find the best 10 pairs or whatever...
It smells totally like "data dredging"...
Which will produce many spurious pairs mixed in with solid, tradeable pairs.
And who is qualified to weed out the dogs?

I wouldn't take Louis Capital's data... if they gave it to me for free.

My approach...
Where you limit your analysis to a homogenous universe...
Like the above ** for example only ** gold mining stock universe versus gold futures...
Is infinitely superior...
And almost completely avoids the problem of "data dredging" and spurious pairs.

But it requires hardcore expertise on the part of the traders...
Which is always in very short supply.
 
Quote from HoundDogOne:

I read the Louis Capital article 3 months ago...

They are in the business of selling financial products based on pairs/basket trading...
Very expensive financial products...
Where 100 hedge funds may be getting the same information...
Unless you pay them extra to get special treatment or data.
More...

I only posted the link(s) because they were "real world" examples. Not saying that they are good or bad, but just an outline to understand from reading/book knowledge about pairs to seeing a client and fund real world example.

I do agree that with anything involved for trading that you will have to search and develop for an "edge."

Thank you for your insight. What can you recommend for an individual investor in terms of programing language and database for getting started? VBA, MySQL?

Is there anything thing else you can pass along without giving away too much?
 
Quote from Bruto Blukowski:

I only posted the link(s) because they were "real world" examples. Not saying that they are good or bad, but just an outline to understand from reading/book knowledge about pairs to seeing a client and fund real world example.

I do agree that with anything involved for trading that you will have to search and develop for an "edge."

Thank you for your insight. What can you recommend for an individual investor in terms of programing language and database for getting started? VBA, MySQL?

Is there anything thing else you can pass along without giving away too much?
More...

As a professional software engineer who became a trader at age 34...
And has spent most of his life obsessed with developing quantitative trading software...
It's hard for me to imagine how a "hobbyist programmer"...
Could have the "intellectual training" in structure and logic and software design to make this work well.

It's the real-time software using APIs and Automated Systems that is beyond the capabilities of a hobbyist...
But using Excel and VBA, I suppose, a determined hobbyist could develop a perfectly viable ** small scale ** basket trading system.

A cab driver may deliver a baby...
But is totally f*cked if any complications arise.

On the other hand...
This is not rocket science...
And the language and tools you choose don't really matter...
And about one second latency in real-time systems is OK...
Because you are never gonna be competing on the millisecond playing field with the Big Players.

And more critical analysis on Louis Capital and the like:

(1) Pairs of very liquid securities are completely worthless... the financial markets are too efficient.

To use an extreme example...
If the US 2 Year Note and the 5 Year Note drift away from a historical ratio...
It's common knowledge... and in no way a trading opportunity.

(2) Great tradeable pairs are mostly found in complex or illiquid securities...
What I call orphan securities... because no one is interested in them.

But if Louis Capital gives an illiquid pair to 100 hedge funds at 8:00 AM...
Both stocks are gonna totally gap at 9:30... and trade unnaturally for days/weeks.

For sure there's lots of front-running going on...
Like the people paying $1000 and getting the list on Tuesday...
Are buying stock from people paying $10,000 and getting the list Monday.
Even if this was illegal... so what... hardly no one ever gets caught doing anything fraudulent.

That's why this kind of thing must be developed from scratch in house.
The idea that you can get winning trades from a Third Party is ** always an illusion **.
 
Quote from HoundDogOne:

As a professional software engineer who became a trader at age 34...
And has spent most of his life obsessed with developing quantitative trading software...
It's hard for me to imagine how a "hobbyist programmer"...
Could have the "intellectual training" in structure and logic and software design to make this work well.

It's the real-time software using APIs and Automated Systems that is beyond the capabilities of a hobbyist...
But using Excel and VBA, I suppose, a determined hobbyist could develop a perfectly viable ** small scale ** basket trading system.

A cab driver may deliver a baby...
But is totally f*cked if any complications arise.

On the other hand...
This is not rocket science...
And the language and tools you choose don't really matter...
And about one second latency in real-time systems is OK...
Because you are never gonna be competing on the millisecond playing field with the Big Players.

And more critical analysis on Louis Capital and the like:

(1) Pairs of very liquid securities are completely worthless... the financial markets are too efficient.

To use an extreme example...
If the US 2 Year Note and the 5 Year Note drift away from a historical ratio...
It's common knowledge... and in no way a trading opportunity.

(2) Great tradeable pairs are mostly found in complex or illiquid securities...
What I call orphan securities... because no one is interested in them.

But if Louis Capital gives an illiquid pair to 100 hedge funds at 8:00 AM...
Both stocks are gonna totally gap at 9:30... and trade unnaturally for days/weeks.

For sure there's lots of front-running going on...
Like the people paying $1000 and getting the list on Tuesday...
Are buying stock from people paying $10,000 and getting the list Monday.
Even if this was illegal... so what... hardly no one ever gets caught doing anything fraudulent.

That's why this kind of thing must be developed from scratch in house.
The idea that you can get winning trades from a Third Party is ** always an illusion **.
More...

Surprisingly insightful for ET.

Another thing I would add is that perceived liquidity can be incredibly misleading.

Also, it's important to mention the issues associated with trading illiquid securities in this manner

1. Impossible to put on size without giving up a lot of edge, thereby putting a nice cap on the money you will make trading this way

2. Once you have size on, it's almost impossible to get out without giving up a lot of profits, especially when the illiquid leg is the one moving against you

3. Illiquid and complex securities are illiquid for a reason - one of them could be their complexity... many times there may be a perfectly reasonable explanation for the divergence that evades you
 
Quote from ig0r:

Surprisingly insightful for ET.

Another thing I would add is that perceived liquidity can be incredibly misleading.

Also, it's important to mention the issues associated with trading illiquid securities in this manner

1. Impossible to put on size without giving up a lot of edge, thereby putting a nice cap on the money you will make trading this way

2. Once you have size on, it's almost impossible to get out without giving up a lot of profits, especially when the illiquid leg is the one moving against you

3. Illiquid and complex securities are illiquid for a reason - one of them could be their complexity... many times there may be a perfectly reasonable explanation for the divergence that evades you
More...


In response to your points:

(1) One does not trade illiquid securities "in size".
Rather... one tracks 100s of illiquid securities and the overall volume adds up.
So the absolute profit "cap" might be somewhere in the low 8 figures for NYSE listed...
Which means the Big Players and black boxes are out of the picture...
And, often, it's just me and the Specialist... and some widows and an orphan or two.

But my methodology is very adaptable...
If it ever came to wrestling with 8 figure "problems".

(2) I always have 2 things in my favor:

(a) entering into a mispriced position due to market inefficiencies with reversion to mean on my side
(b) the bid/ask spread...
which is still typically $0.05 to $0.10 in a stock that trades 50K-100K shares/day

(3)
> many times there may be a perfectly
> reasonable explanation for the
>divergence that evades you

Yes.

That's why I have repeatedly said...
That this only works well in the hands of very experienced traders.

The main benefit of experience...
Is that one has suffered through every possible pitfall indigenous to a class of securities...
And therefore avoids repeating such losing trades...
That are not easily screened out using quantitative methods.
 
Quote from HoundDogOne:

It's the real-time software using APIs and Automated Systems that is beyond the capabilities of a hobbyist...
But using Excel and VBA, I suppose, a determined hobbyist could develop a perfectly viable ** small scale ** basket trading system.

On the other hand...
This is not rocket science...
And the language and tools you choose don't really matter...
And about one second latency in real-time systems is OK...
Because you are never gonna be competing on the millisecond playing field with the Big Players.
More...

Thank you for your continued expertise and insights.

For you positions and trading model, can you state the average holding period? Holding overnight?
 
Quote from Bruto Blukowski:

Thank you for your continued expertise and insights.

For you positions and trading model, can you state the average holding period? Holding overnight?
More...

This applies to NYSE/AMEX stocks...
With average daily volume between 5,000/day and 100,000/day.

Holding period minutes to hours to 1-2 days...
To absolute max 1-2 weeks for trading out of problem positions at a loss.

If you are scalping for small profits...
You have to be absolutely ruthless in closing out or hedging losing positions.
This is probably the hardest thing for a trader to learn to do.

You cannot trade lower volume stocks without holding overnight...
Because you will be forced to liquidate too many positions at sub-optimal prices...
So that is a significant limitation in terms of leverage.
 
is anyone aware of a way to do this in tradestation besides putting both of the stocks on a chart and visually viewing the spread? What is the best way to run the correlation? Is there an outside program that you need or can it be run in tradestation?
 
Quote from mightymight:

is anyone aware of a way to do this in tradestation besides putting both of the stocks on a chart and visually viewing the spread? What is the best way to run the correlation? Is there an outside program that you need or can it be run in tradestation?
More...

Excel or OpenOffice equivalent.
 
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