Pairs Trading Strategy Model

[m&m&m]

Quote from DerferMark:


m&m&m,
How many pairs do you follow/trade? Care to provide any insight on what characteristics you look for to determine prediction of divergence vs. reversion for a particular pair? Your win/loss ratio is excellent.

Hi,
For back testing, I used only S&P500 stocks for 1998-2002. Actually, to get correlation for January 1998 I used data since 1996.
I do not trade many pairs, but follow all the combinations available for Russell 1000, S&P500 and Nasdaq100, though I like stocks with a volume. I hope I’m close to finish a system that will trade automatically. For now I trade just 4 –5 pairs at a time. I know, some guys were laughing here about my volume, and specially for pairs trading you do need size (I for example give up about 4 percent per position just on commissions), but I think you can risk some serious money when all experiments are done.
Regarding divergence vs. reversion – well, I like trends. If a pair is in a trend – I follow it (meaning I bet pair will diverse even more). If it’s not in a trend (yet) – I bet it will reverse. My experience shows that some pairs (appx. 1 in 3 or 4) that I like (when I say “I like” I mean – the program likes, I may not like it at all if I look on a chart) – some of them instead of reversing will diverse even more, and at some point they will fall into trend. At that point we (me and the program) also like them and I follow the trend. There are some indicators to decide if a pair is in a trend or not – ADX for one. Unfortunately, I was not able yet to back test the system with ADX – I need intra-day data for pairs to do that. In real life I go to Qcharts to get ADX for the pairs, since this is the only one charting program I know that have ADX for pairs – www.pairtrading.com do not have ADX, though they recently implemented MACD (which could be used for entry-exit points). During back testing I used another function (some function of standard deviation) that also can show if a pair is in a trend.
Here is one more of my current positions (I had it the previous time I uploaded few positions, but back then it did not move yet). Here you can see why I liked it and why I entered it at that time (MACD crossed 9days EMA)

 

[TMTrader]

I've just noticed this thread is one year old today

 

[seisan]

All thanks to thread-starter Neutral Al !

And it has proved to be one of the best threads on ET!




By the way, just where IS Neutral Al....?

 

[seisan]

Cont'd:

Through its several resurrections,
traders continue to step up and
make solid pairs strategy modeling
contributions to carry the thread forward.

The ever increasing number of "views"
speaks for itself.


Expect Neutral Al and more than a few
others to re-emerge as even better traders!

 

[Neutral_Al]

Quote from seisan:

All thanks to thread-starter Neutral Al !

And it has proved to be one of the best threads on ET!




By the way, just where IS Neutral Al....?

Hi seisan,
Hi everybody,

Thank you for your kind words.
It is nice to realize that together we have created something that is of interest to so many people. The numbers of views and responses indicate that market neutral trading, pairs trading specifically, is not being overlooked by the trading community.
Reading through the posts, I have noticed several “theme” questions that come up time and time again. Here are my thoughts on the subject:
1.Why trade pairs instead of a single security/index? By its nature, pairs trading is not a “money making” instrument. It is a risk management tool. It was created, and is utilized the most by professionals who manage large portfolios and are responsible for other people’s money. If your goal is to preserve your principle and enjoy a relatively small but steady increase of your portfolio, then pairs trading is for you. If you are in the market for a quick and large profit, and able to stomach significant volatility in your account, then pairs trading is not your cup of tea. Personally, after doing it exclusively for a year, I find pairs trading to be the least stressful and the most rewarding trading strategy I have ever used. It gives me acceptable returns ( +38% for the year), and most importantly, life style that I want. I hate to spend all my days in front of the computer.
2.Is pairs trading dead? It is very much alive with me, but I can see the point. Intraday scalping spreads lost much of its appeal after the decimalization took place. Increase in program trading with most of the volume attributed to a few major institutions makes it even more difficult. However, it sounds like Mr. Slavin at www.pairtrader.com is doing well. It takes a special talent to be able to do what he does. Positional pairs trading mean reversion has also slowed down a bit. I attribute it to this incredible complacency in the markets that we experience as of late.
3.The LTCM story. Yes, they did pairs trading. However, that is not what killed them. They died of the same plague that kills any Market participant i.e. lack of discipline in adhering to the basic trading principles. You have to have STOP LOSSES!
4.A lot of people ask me in the private e-mail whether the www.pairstrading.com ‘s manual is any good. I bought it. I used it to create my model. So far it worked fine for me. However, I can see a sophisticated stat arb trader being disappointed. There is nothing in the manual about cointegration, time series analysis, fuzzy logic or any other advanced stat arb tools.

On the final note, let me know if you are interested to see my trading ideas. I’ll be happy to post them for your review.

Good luck to all. Keep it going.

Al

 

[H2O]

Quote from Neutral_Al:




On the final note, let me know if you are interested to see my trading ideas. I’ll be happy to post them for your review.



Al

Al, I would be more than happy to see your ideas. I've been trading spreads a while agoo and start to pick it up again.
Any recent trading ideas / trading history would be a great review.

Thanks in advance,

 

[vonk]

Neutral_AI FYI...

This came to me in an email from pairtrader.com...
______________________________________________
Slavin Bids Farewell - I’ll Be Back by Steve Slavin

As many of you know, I haven’ t been around much lately. August is always a slow month, but I’ ve taken this time to
reorganize and consider new challenges. I’ ve had a horrible year consistently making money – it’ s night and day from last
year. Almost every month I’ m on the positive side of the ledger, but with a wife, kids, a big mortgage, and investors to
answer to, my wife and I have been asking “is it enough?” Unfortunately, it isn’ t.
That’ s the reality of this work. There are times when the market is so generous and times when it shuts down. In the later,
taking pennies from the market is darn near impossible without taking on extra risk. That’ s the key there – can you take
business risk that’ s controlled and calculated. It makes no sense to risk $1.00 to make .20 cents in a dead market. In a fast
and more volatile market you can get away with it more often since you have 20 times more opportunity to make it back,
but we all know this hasn’ t been the kind of market we’ ve seen lately.
By no means am I making excuses for my performance. Clearly I didn’ t adapt quick enough by lengthening my time
horizons, but I never felt comfortable with the risk in doing so. It blows me away that I could go from making $20-40k a
month to so little, but my story is not unique.
So, what’ s next for me? I’ m exploring a job offer at a great institutional fixed income desk in Columbus, but I’ m not sure I
can maintain two households in the short run. I’ ve also been offered a job running brokerage operations at a small bank.
Do I see myself coming back to trading someday? Are you kidding me? Absolutely! I just need a more generous market
and a bit more cash to buy me more time in the slower months. I certainly know I can make a ton with the right conditions,
but for now I’ m excited about a new challenge.
What’ s next for PairCo? To go into a new position where I use my Series 7, compliance departments are telling me I need
to dissolve my interests in PairCo and PairCo Capital Holdings. Fortunately, Darren Clifford in Vancouver has really
stepped up to the plate and made a further commitment into the concepts of PairCo and PCH by buying me out. Thanks
Darren! Rob’ s assured me the door is wide open for my return someday, but for now, I’ m stepping down and letting them
run the show. I expect nothing but great things from them! PairCo has been a great experience and shall always be in debt
to Rob for his great leadership and friendship.
Best of luck to everyone! Remember to keep your risk in check, and be prepared to keep changing your methods – over
and over.
Regards,

 

[seisan]

TM Trader - now see what you started?!

Neutral Al - thanks for the appearance!
Everybody's been re-reading your post
and
waiting for you to show us
some more trading ideas...

vonk - thanks for passing on Slavin's particulars
with his bottom line trading reminders to
absolutely control risk management
and
constantly tweak one's strategy methods to the market.

All others - keep up the posts - it's September, already...!

djclif - yeah, you've got your own Conference Room
and are practically running the company now...
...but, send us a post at least once a month or so!
Everybody's just waitin' to kick it around a little....
...'specially since you're now a bona fide ET'er...!

 

[djclif]

Seisan,

You asked for a post once a month, I will try to make it more frequent then that. My biggest problem is that I am too busy trading, working on our website, mentoring new traders, and writing automated trading strategies. I have a new personal assistant I will make sure she reminds me to be more active within these discussions.

For those of you who are not familiar with my background, I am the CFO for pairtrader.com, a professional prop trader (through Bright Trading), I sponsor under capitalized prop traders, and write automated trading strategies. Enough things to keep me busy. Reading through some of the posts here it appears like the group has had some great creative discussions, I look forward to contributing and learning more with everyone here.

To start, I should probably tell everyone the style of pairtrading I am using to make money in this market. I trade multiple pair strategies which include relative strength pair baskets, swing trading pairs, pair investing, trading tight 'arb' spreads, pair opens, and pair crutch trading. The list is broad, but I am using each of these strategies everyday while I trade. If anyone has any questions on these I would be happy to fill you in.

Looking forward to some great discussions,

Cheers,

Darren

 

[seisan]

We just knew you're doing a supreme balancing act with all that
you've got going on - that's why we egged you on all the more...

A trading pro and a great sport!
Just a typical patience and discipline kinda' guy, eh....?

Thanks for comin' aboard Darren.