Pairs Trading Strategy Model

15:06 ET Pair trade call in the brokers
Hearing a pair trade call to short GS and go long LEH. According to this research call, GS is trading at a 47% premium to LEH on price to tangible book basis (2.8x vs. 1.9x) and a 32% premium to forward 04 earnings at 17.5x vs. 13.2x, respectively. The gap is significant given LEH's increasing market share in both Fixed Income and Equity trading. In addition, the 4th round of Goldman IPO shares unlocking on Thursday; the last time this occurred (24 mln shares on 5/08/03) the stock was off on significant volume.

nitro
 
I have done a lot of backtesting of pairs trading and as for all trading strategies there are periods that it works perfectly and there are periods that the strategy generates losses. And you don't know when losing period comes for a specific pair. I was not able to find a magic pair that is constantly profitable over long period. Pairs trading is not significantly different from simultaneously trading long and short system and selecting log and short stock based on some other criteria. And also the correlation is not the last measure for the profitability.
 
Quote from a5519:

And also the correlation is not the last measure for the profitability.
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Correlation just give you some kind of protection against market moves - Market Neutural
 
Quote from Ron In-a-sauna:

can anyone do backtesting on a pair?
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I can do that, but probably not before the weekend. My current approach is very short term moves, you might even call it scalping pairs...
 
thanks for the replies, i resolved the issue however...
did anyone take the gs/leh pair... well have to see if the lock up sinks GS tommorrow, i wa more interested in that aspect of teh trade vs. the valuation call, that to me is more pairs investing and i am not an investor...
 
This thread seems to keep returning to questions regarding the nature of markets (general), the process by which future moves can be forecasted and the best way to exploit those moves.
To look for pairs which " consistently make money " is in my opinion not the question. Why? because of the dynamics of the markets. If an opportunity is seen it will be exploited - fast. The market is not a static being and therefore analysed as such, seeking fixed laws governing future behaviour. It must be seen as dynamic - reacting to many pieces of information at any one time.
So where does that leave us ?
If our hypothesis is that R regresses to the mean - sure we need to test that hypothesis by "back testing"
We can test SCIENTIFICALLY correlation, standard deviation etc. etc.
and what does that tell us ?- the probability of future events happening based on historical events.
So armed with this information we can enter the market with the hope of exploiting it.
Always remember you may be wrong.
At the end of the day it is only a bet.
 
Sure - everything's a bet in the markets. But pairs trading is a higher probability bet than trading flat price. I scalp pairs and butterflys all day long. It works if you can trade size and your execution costs are low.
 
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