Pairs trading is a market-neutral trading strategy enabling traders to profit from virtually any market conditions: uptrend, downtrend, or sideways movement. This strategy is categorized as a statistical arbitrage and convergence trading strategy.

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42 views

### Need help with Pairs Trading Performance Calculation

I currently write my master thesis about pairs trading. I am now stuck at calculating the performance of my pairs correctly: In my first column, I have got the current position in the market (0=...
40 views

### Managing a portfolio of pair trades

When arbitraging ETF holdings against the ETF, how does one manage the portfolio over time? Assume the strategy creates a long signal in pair A (stock X/ ETF) and a short signal in pair B ( stock Y / ...
62 views

### Pairs Trading: Normalized price series (co-integrated and correlated) always end up diverging

Need some expert advice and suggestions: I am trying out pairs trading or statistical arbitrage (as traders say). But even if two price series are co-integrated (ADF test, Hurst exponent, Ornstein–...
95 views

### Why is OLS based spread not reflective of actual difference?

I'm trying to define and track the spread between two time series (data available here), for the purpose of learning pair trading basics. When running a cointegration test the two series seem to be ...
49 views

### Constructing a Beta Neutral Hedge in a Pairs Strategy

Looking for resources / explanation. Creating a dollar neutral hedge is easy - stockprice-a/stockprice-b How do I create a beta neutral hedge? I find discussions but no explicit derivation ...
60 views

### Correct calculation of returns from a pairs trade

I am trying to understand how pairs trading works but I am confused about how to go about calculating the return on the pairs trade when I reverse my positions. I have been reading 'Pairs Trading - ...
38 views

### What value to put in lm() function when testing for cointegration (R)

I'm a CS student working on a financial computing project + have a question regarding cointegration testing using linear regression with the lm() function. https://www.rdocumentation.org/packages/...
34 views

### Sizing a beta neutral Pairs trading with an allocation limit

Hopefully a simple one for someone. I've a pair of stocks A and B. The beta adjusted spreads tell me I need to be selling A and buying B, my beta for B is 1.5, so in order to get a beta neutral pair ...
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84 views

### pairs trading algorithm with returns

I'm having a difficulty grasping how to write a pair algorithm using returns instead of prices. With price differences, I have the mean difference over a long time period. When the current price ...
49 views

### Pair Trade - Should stock order matter

I am testing a simple pair trading algorithm and I'm having problems if I swap the stocks around. I don't know which stock should be X and which should be Y. When I swap them I get very different ...
29 views

### How can I normalize price data for 2 financial instruments from different categories?

Lets say I want to build a divergence / convergence strategy with FOREX currency pair and a correlated commodity. How can I normalize the prices so that I get an accurate idea of the movements of each,...
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446 views

### Calculating Sharpe Ratio with dynamic position sizing

I'm currently backtesting a mean reversion pairs trading strategy. However, instead of simple long or short trading signals, I'm using multiple "levels", where the further away the spread is from the ...
220 views

### Pair trading strategies in fixed income

We usually hear about finding cointegrated pairs of stocks in pair trading, but it seems it is not as developed in fixed income despite the fact that the spectrum of securities is large (different ...
7k views

482 views

### If two price series are cointegrated but not correlated, how do I find the hedge ratio?

Mathematically, what is going on here?
148 views

### When constructing a cointegrating series, does choosing the linear regression with the lowest ADF test statistic yield the optimal hedging ratio?

Multiple sources say that you should find the optimal hedging ratio between two stocks in a pairs trade by conducting 2 linear regressions (with each stock as the independent variable), and using ...
578 views

### Standard deviation of a long-short portfolio with net position zero

I've come across the following question and I'm slightly stuck in answering it: Suppose you have a two-stock portfolio that is long one stock of asset A, and short one stock of asset B, with A ...
777 views

### Cointegration vs combination of returns

Hi Quantitative Finance, I understand that there are a wealth of pairs trading models out there. Recently, it got me thinking as to why we go through the trouble to find cointegrated pairs while we ...
834 views

### Why isn't it appropriate to use correlation between prices in a pairs trade strategy?

I've already seen this question and read through all the answers, but I'm still confused about why you shouldn't use price correlation in a pairs trade strategy. For example, if I'm looking at the ...
184 views

### Is this the correct way to hedge two securities against each other?

Let's say I believe that $ts_1$ and $ts_2$ move together and I would like to pairs trade them. Am I correct in understanding that to hedge them against each other I would get their $Var_1$, $Var_2$, ...
1k views

### How to “Standard Beta Hedge”?

Let's say I have 2 time-series, how would I "standard beta hedge" them against each other? For example, what if the position in 1 timeseries is 100 shares at 16 USD per share. Another time-series is ...
289 views

I have intuition that cointegration between elements of pair of equities somehow contradicts pairs trading strategies. Because the better is linear fit of the model the less opportunities we have for ...
5k views

### Calculating the returns of a long/short strategy

I feel like an idiot asking this but i haven't found the answer anywhere. I have backtestest a paris trading strategy, while calculating the returns of the strategy I run into some problems when the ...
174 views

### Relative Value Trading of American Style Options on Futures, Calcuating hedging ratios?

I am interested in Relative Value Trading of American style options on futures and have not found a whole lot of literature on it. The best resource I have discovered so far is a few pages in Colin ...
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I am testing a pair trading strategy. Every day I recalculate the hedge ratio using the past N prices of the 2 underlying. With the hedge ratio, I calculate the past N spreads and do an ADF test to ...
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### calculating the pair weights from log price hedge ratio

I am calculating the hedge ratio using log prices: $$\ln(A) = \text{hedge_ratio} \cdot \ln(B)$$ How do I convert the hedge_ratio into a number of shares of A vs....
254 views

### How do you decide what time frame you're going to use when testing for cointegration?

I've been fiddling around with different time frames when doing tests for cointegration between two timeseries, and I've realized that the dates that you use for your start/stop of the test will ...
346 views

### How can I apply error correction model in pairs trading?

I have read Vidyamurthy and others, but did not find clear example of error correction model (ECM) application in pairs trading. How should I use the ECM model in the pairs trading? How to use ECM ...
3k views

### Close or Adjusted Prices when Backtesting

I've been doing this for some years now, but recently, since I started fiddling around with an old pairs trading strat of mine again, when updating the databases before running the tests, I was ...
715 views

### pair trading cointegration - calculating shares quantities traded, portfolio value and returns

I have a trading strategy based on the cointegration of X and Y where beta derived from the regression is 0.7. My initial capital to invest is 1000. My understanding that the quantities of X and Y to ...
407 views

### What causes poor returns in pair trading of very cointegrated securities?

I've been running some backtests of a pair trading strategy on 1 year worth of 5 min bars of two securities and I've noticed pretty poor returns, especially once transaction costs are taken into ...
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Lets say I have two stocks x and y and their corresponding stock price p(x) and p(y). consider HR as hedge ratio. Then we can calculate the spread using this equation. $spread=p(x)-HR*p(y)$ from ...
2k views

### What is the pseudo code for a pairs trading strategy?

I am trying to learn about pairs trading strategy. I know that we have to long and short cointegrated assests simultaneously. But I still have some confusion in how the strategy works. I wrote the ...
389 views

### cointegration strategy

If it can be proved that two time series $$S_t^1=\alpha + \beta S_t^2 + \xi_t$$ representing stocks are correlated, with $\beta=-2$ and then are proved to be cointegrated, how a portfolio should be ...
2k views

### How to trade the Ornstein-Uhlenbeck process?

My question comes from this paper, which is a short version of Avellaneda's paper The picture bellow provides a summary of the equations. Do I understand correctly that in order to trade OU process ...
634 views

Trying to evaluate model for pairs trading. Consider classic formula: $\frac{dP}{P} = adt+b\frac{dQ}{Q}+dX$, where $P$ and $Q$ are stock prices, and $X$ is a mean reverting process (MRP) and $a$ is ...