Pairs Trading Strategy Model

Quote from TruthTeller:

Correct me if I am wrong - and I'm sure that somebody will - but who is in back of this fairly recent emphasis on pairs trading?

Isn't it firms that earn a large part of their revenue from commissions? The very same folks who brought you the strategy of scalping for fractions circa 1998-2000, whereby a zillion poor suckers enjoyed all the benefits of carpel tunnel syndrome while spending 20K a month in fees for their "employers"?

But hey, you got to be a "professional" with a license(!) to trade there, so they MUST know something you don't, right?

Anyone get the picture?
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Well,

I do think that firms do this on "purpose" and for good reason. You need to read any introductory text about markets. THE ABSOLUTE axiomatic principle from which all other trading stems is the principle of a RISKLESS ARBITRAGE. At the CORE of understanding all trading is some form of arbitrage, all the way up the food chain to the speculators. Arbitrage profits (heat death) by it's very nature is the culmination of many markets.

Saying that a pro firm encourages this kind of trading is like saying that a young turtle after hatching has an urge to go into the sea.

nitro
 
Quote from DaveN:



TruthTeller,

I'm sorry if these recent posts are coming across wrong.
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Not my intent to slam you, Moderator. But I see and hear of a lot of prop firms pushing this as the "new thing" when in fact it serves their purposes of generating fees ofttimes more than generating income for traders. Sorry. A sore subject of mine.
 
Quoted from: "Searching for Alpha," Ben Warwick - page 149.


Andrew Lo and A. Craig Mackinlay put a unique spin on this issue in thier book "A Non-Random Walk Down Wall Street." When they began examining stock prices in 1985, they were shocked to find a substantial degree of auto-correlative behavior - evidence that previous price changes could have been used to forecast changes in the next period. Their findings were sufficiently overwhelming as to refute the random walk hypothesis, which states that asset prices changes are totally unpredictable.

The most important insight from their work occured when they repeated the study 11 years later, using prices from 1986 to 1996. This newest data conformed more closely with the random walk model than the original sample period. Upon futher investigation, they learned that over the past decade several investment firms - most notably Morgan Stanley and D. E. Shaw - were engaged in a type of stock trading specifically designed to take advantage of the kinds of patterns uncovered in their earlier study. Known at the time as "pairs trading" - and now referred to as statistical arbitrage - these strategies faired quite well until recently, but are now regarded as a very competitive and thin-margin business because of the proliferation of hedge funds engaged in this type of market activity.
 
Just sounds like sector trading to me....Cmon hasnt everyone done pairs trading in advertently. Watch the sectors and make the calls. Its still just risk management....

Ok I am doing TRIPLETS NOW. My methodology will soon be published.:D

Seems like someone is always coming up with the secret potion.
 
Quote from TruthTeller:



Not my intent to slam you, Moderator. But I see and hear of a lot of prop firms pushing this as the "new thing" when in fact it serves their purposes of generating fees ofttimes more than generating income for traders. Sorry. A sore subject of mine.
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You are missing the point. What's important is not how much the firm makes, but how much you (the trader) makes.

The firms push this strategy, yes, maybe because it generates more in commissions, but that is irrelevant. The fact is, it is arb and arb works, if you have costs low enough and knowledge enough to exploit it.

If you can take home twice as much in profits by paying your firm/broker six times as much in comms, wouldn't you still do it?

Riskless is not quite true, however, anything truly riskless would have no profit potential. I have found that the good arb traders are usually also good straight up directional traders, so arb may not work for those who are crappy traders to begin with..
 
Quote from esc_trader:

...Riskless is not quite true, however, anything truly riskless would have no profit potential. I have found that the good arb traders are usually also good straight up directional traders, so arb may not work for those who are crappy traders to begin with..
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Riskless Arbitrage DOES exist. However, you and I (well, at least I) do not have the capacity to do it. AFAIK, the person that comes closest to being able to execute a Riskless Arb on the entire ET forum is metooxx.

Statistical Arbitrage does not equal Riskless Arbitrage, but it is a great education to understand many of the Riskless Arbitrage trades anyway and who and how they get executed - in fact, it is the basis of PREM/program trading.

nitro
 
Intraday statistical arbitrage aka pair trading..Not hard.

Its done all the time. You dont need sophisticated model ...

All you need is a sector leading and sector laggard.

Pull up the futures (ex. BTK,ES) and trade. That's it. KISS

It aint brain surgery. :)
 
Quote from FishSauce:

Intraday statistical arbitrage aka pair trading..Not hard.

Its done all the time. You dont need sophisticated model ...

All you need is a sector leading and sector laggard.

Pull up the futures (ex. BTK,ES) and trade. That's it. KISS

It aint brain surgery. :)
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It is not rocket science or brain surgery, however, first you state that one should find a lagging sector and a leading sector - that is not statistical arbitrage, at least not in the classical sense, as there is no STATISTICAL CORRELATION. That is just buying strength/selling weakness, or sector trading.

You then say to pull up the futures, and then give the example BTK which is an index?

nitro :confused:
 
Oops ... didnt proof read. Indices (DJ Titans) and futures (ES).

I know quite a number of intraday pair trading setup. Using autocorrelation, cointegration, CAR, and NONE has outperform a simple sector laggard/leading combo.

If you run the cointegration of a pair based on correlation, the number would not be as good if you ran one using simple sector LL.

Thus there's no point trading based on intraday pairs... just use sector LL


Quote from nitro:


It is not rocket science. First you state that one should find a lagging sector and a leading sector - that is not pair trading, at least not in the classical sense. That is just buying strength/selling weakness, or sector trading.

You then say to pull up the futures, and then give the example BTK which is an index?

nitro :confused:
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Ok.

Now this is making sense. When I pair traded, I had gotten a "brilliant" idea to combine pair trading with sector strength and to play pairs to diverge (but not accross sectors.) I was never quite able to get it going, however, if I ever get a chance to go back to the style, I will pursue it further.

I have never quite gotten the hang of the sector thing. To me, a stock that follows the spoos may or may not lift/fall with the spoos dependig on it's own technicality at the time and less so with it's sector. I am talking about the smallest of time frames btw. I have watched INTC and AMAT VERY carefully in this regard for example, or C, JPM and countless others.

Don Bright and Silk are actually the people I credit with getting me thinking about this. RS7 I think also had a long thread about somthing similar. I have never quite pieced it together though...

nitro
Quote from FishSauce:

Oops ... didnt proof read. Indices (DJ Titans) and futures (ES).

I know quite a number of intraday pair trading setup. Using autocorrelation, cointegration, CAR, and NONE has outperform a simple sector laggard/leading combo.

If you run the cointegration of a pair based on correlation, the number would not be as good if you ran one using simple sector LL.

Thus there's no point trading based on intraday pairs... just use sector LL
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