Questions tagged [pairs-trading]

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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63 views

Fx futures pairs

I want to setup a pairs trade with the Japanese yen as the quote currency and Mexican peso as the basis currency. (long MXP vs JPY) 2 /M6J contracts, notional is 1,250,000 JPY = 10966.5*2 = 21933 USD ...
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Research papers and other resources to learn about useful statistical tools for pairs trading

Brief background: I recently started writing a Python code to find stocks which might be cointegrated. I iterated over a really long list of stocks trying to find a pair which might be cointegrated. ...
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32 views

Variance of trade length for the OU-process

Based on the article by Bertram (2010), I am trying to calculate the variance of the trade length stated in equation [10] of the paper. However, the weights used has a specification that I cannot ...
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What are some ways to weight the basket of securities in high frequency setting?

I'm trying to build a basket of closely related assets $\{S_1, \dots, S_N\}$ that have no general index such as S&P500 and are represented in the high frequency setting. The general idea is to ...
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What do I need the Error correction model for in the two step Engle Granger approach (bivariate Cointegration)

could someone kindly explain what I need the ECM for in a bivariate Cointegration test? I am currently trying to reproduce the results of Rad et al. (2015): "The profitability of pairs trading ...
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612 views

What is the reason for using log prices in Pairs Trading (Cointegration)?

I was wondering, why some of the research papers on pairs trading (using the cointegration approach) are using log prices to determine the spread of a pair? Why are they not simply using regular ...
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How to calculate sharpe ratio for a strategy that has a stoploss and a profit exit condition?

I am working on a pair trading strategy, which either books a profit or holds the position till it hits stop loss over multiple days. I have months where I don't hit stop loss at all and this makes ...
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165 views

Pairs trading/Cointegration confusion

I've been trying to wrap my head around cointegration. Currently I use the log returns of both stocks A and B, calculate the spread given by: $S = log(A) - n*log(B)$ where $n$ is the Hedge Ratio ...
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60 views

Cointegration and hedge ratio

I've recently been looking into pairs trading through cointegration. So far I've used the log returns of stock A and stock B in a rolling OLS to find the hedge ratio. However, I've noticed that for a ...
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69 views

Finding the weights in pairs trading

Could you tell me if the approach below for calculating the weights in a pairs trading strategy is correct? Let's say that my capital is 100. Regression $\ln(y)=b \ln(x) + e$. I find $b=1.2$. $w_{x}+...
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In Pairs Trading: How can high volatility in spreads be explained when there is a market shock?

In my project I tested a Pairs trading strategy in the US equity market for data of 10 years. These 10 years include the financial crisis (2007-2008). The strategy follows a Cointegration approach. ...
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54 views

How can I find the weights for a pairs trading strategy

I have found a python code for a pairs trading strategy and I cannot understand how it calculates the weights for the two stocks. It runs a regression log(y)~log(x) (without intercept). Then it takes ...
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31 views

Number of observations required for cointegration test

Hopefully a very simple one. I've got two assets daily close prices. How many observations should I use to test for cointegration between these two assets ? Any pointers wuold be great. A
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173 views

How to compute returns of a Pairs Trading Strategy with different holding periods?

I am currently working on a project where I am testing a Pairs Trading Strategy based on Cointegration. In this strategy I am considering to trade a couple of hundred stock pairs every day over a time ...
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112 views

Pairs Trading Strategy Pre-Selection

I am writing paper on the profitability of the pairs trading strategy using US equities. I have done a pre-check to see which business sectors have stocks that are cointegrated. The utilities sector ...
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115 views

Pairs Trading (Cointegration Approach) - Daily Cointegration Test

I have a question regarding the Pairs Trading strategy based on the Cointegration Approach. Most of the papers/literature I found on Pairs Trading using the Cointegration Approach are usually testing ...
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176 views

What should the look-back period be when calculating Cointegration?

So I am confused as to what the look-back period should be when calculating Cointegration. By this I mean when running for example a Johansen or ADF test, should my look-back period be 6 months?...
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88 views

Should I calculate a spread using stock prices or the ratio?

So I am creating a trading algorithm thats uses cointegration, for a pairs trading strategy. Imagine there is stock A for 100 dollars and stock B for 25 dollars. My questions is when caulcating the ...
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60 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 / ...
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198 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–...
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164 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 ...
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200 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 ...
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192 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 - ...
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47 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/...
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217 views

Generating buy/sell signals in pairs trading

I'm reading a quantitative trading book"Quantitative Trading with R" by Harry Georgakopoulos. In the pairs trading section, there's an example that creates the spread and generate buy/sell ...
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154 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 ...
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62 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 ...
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197 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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938 views

Calculating % Return in Pairs Trading Strategy

Hi guys Could you help me here? I would like to calculate the return of a Pairs Trading strategy. For example: 18/11 - Open the Trade: I will go long on A and Short on B: Stock A : $ 32.24 Stock B ...
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174 views

Pairs Trading parameters

I am looking to optimize the open/close signals and time for a pairs trading strategy my partner and I are researching. We don't want to go p-hacking so we have been trying to decide: We have 20+ ...
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65 views

Negatively Correlated Assets with similar medium-term trends

Theoretically, one could have stock prices with returns $\rho_1(k)$ and $\rho_2(k)$ having mean values $\mu_1$ and $\mu_2$, but still be negatively correlated with $$ \mathbb{E}[(\rho_1(k)-\mu_1)(\...
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201 views

Pairs Trading situation with spread changes

I'm setting up pairs trades by summing the distances squared (SSD). After determining the best pairs, I have to track the spread between the normalized prices. Am I noticing something that is ...
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244 views

Bootstrap Method for Assessing Pairs Trading Performance

After reading this paper I tried to replicate it. I almost done, but I am stuck on the section 3.6 where the author constructs a random pair (how he constructs this?) for Assessing Pairs Trading ...
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621 views

Pair trading - short / long the spread

I am wading into pair trading concepts. Here is one article I've read. I understand for these strategies our intention is to go long on one asset and short another, however I do not understand what ...
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243 views

generalisation of cointegrated stock pair strategies to multiple cointegration

Question: as it is well known, there are strategies to trade pairs of stocks which are known to be co-integrated. See for instance here: https://medium.com/auquan/pairs-trading-data-science-...
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Pair trading: Hege ratio by price ratio or by regression on the stocks

So I feel things like this question do exist on the site however I failed to form a conclusion based on what was written, so I decided to formulate my query as exactly as possible and hopefully anyone ...
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146 views

Pairs trading strategy: Portfolio returns and NAV

Currently trying a pairs trading approach using cointegration. Tried both formations: $$log(P_t^A)=log(P_t^B) \hat{\gamma}+\hat{\mu}+\epsilon_t \hspace{0.5cm} (1)$$ $$P_t^A=P_t^B \hat{\gamma}+\hat{\...
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71 views

Short sale and zero investmest strategy

Suppose I want to build a pairs trading strategy. Theory says that we can create a zero-investment portfolio by going long stock A and short-selling stock B, given a certain hedge ratio. My question ...
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Cointegration and Ratio Pair Trading

I'm having some confusion doing Engle-Granger Cointegration test and then trade the ratio. Methodology: Run an OLS fit for A and B price time series without a constant. Therefore, $\hat{Y} = \gamma \...
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777 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 ...
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312 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 ...
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13k views

How to calculate Sharpe Ratio from $ returns?

I have a pairs strategy that I am trying to calculate the sharpe ratio for. Currently I am using python for my analysis and calculation. I have a dataframe that contains the cumulative returns in $'s ...
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668 views
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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 ...
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1k 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 ...
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1k 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 ...
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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 ...
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202 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 $Var_1$, $Var_2$, ...
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2k 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 ...
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Cointegration and pairs trading

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 ...