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11 votes

How to calculate Sharpe Ratio from $ returns?

Let's say your cumulative return series is $\{R_i \mid i=0,1,...,N-1\}$ of length $N$ days. There's 3 conventional ways to do this at this stage. You may convert the cumulative dollar return curve ...
madilyn's user avatar
  • 5,240
11 votes
Accepted

What is the pseudo code for a pairs trading strategy?

The following link has a good summary of a typical pair trading strategy: https://www.quantstart.com/articles/Backtesting-An-Intraday-Mean-Reversion-Pairs-Strategy-Between-SPY-And-IWM It actually ...
KarolisR's user avatar
  • 693
8 votes
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What is the reason for using log prices in Pairs Trading (Cointegration)?

I'm assuming that the paper you're referring to uses the Engle-Granger test for cointegration. The standard test procedure checks for unit roots in the residuals of a linear regression. It is a "...
databento's user avatar
  • 2,548
6 votes
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Calculating the returns of a long/short strategy

There are two ways to calculate the returns. One way is to calculate the net asset value (NAV) of your portfolio. For the long side the NAV is the value of your stock holdings. For the short side the ...
RRG's user avatar
  • 1,034
6 votes

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

A few possibilities - Trading costs kill your returns (often a problem for very highly correlated securities) Mean reversion of the cointegration spread is either very weak, or happens over periods ...
Chris Taylor's user avatar
  • 5,931
5 votes

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

You could, and it doesn't hurt for you to test this yourself. Some of my best work has come from drawing the opposite conclusion to conventional wisdom or stylized "facts" in publications. That said, ...
madilyn's user avatar
  • 5,240
5 votes

Pair trading - short / long the spread

first keep in mind how spread is constructed, say it's $y - \beta x$, $y$ being asset $A$'s price and $x$ being that of asset $B$. Then long the spread is when $A$ is under-performing, because our ...
numerairX's user avatar
  • 609
5 votes
Accepted

Pair trading - short / long the spread

From the link in your OP, the article is talking about buying one stock versus shorting the other. The distance pair trading system they are describing always plays the distance to converge. It just ...
amdopt's user avatar
  • 4,348
5 votes

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

This is for better linearity/normality in the QQ plot at the tails, which as both @noob2 and @rkr allude to, give a better fit and hence better properties for normalizing the residuals with z-scoring ...
Katie's user avatar
  • 304
5 votes
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How to correctly explain the current price action in a trading chart with the Hurst Exponent found?

Does the above mean that I should consider opening short positions for these trading pairs when I get a Hurst Exponent greater than 0.5 and also its prices come from top to the bottom? No. Hurst ...
amdopt's user avatar
  • 4,348
4 votes

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

If you are correlating prices that would imply that you are sizing positions based on the number of shares in each position. This can result in a book that is very biased in terms of dollars invested....
amdopt's user avatar
  • 4,348
4 votes

Calculating Sharpe Ratio with dynamic position sizing

To calculate the sharpe ratio of a strategy backtest you should ultimately go back in $ space and calculate for every day your PNL (profit and loss), not returns, because at the end of the day this ...
Ezy's user avatar
  • 2,187
4 votes

Pair trading - short / long the spread

There's 2 ways to remember the sign convention: If you're trading an exchange-listed spread, then the convention is that going long on the spread A-B implies buying A and selling B. Vice versa, ...
madilyn's user avatar
  • 5,240
4 votes
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What is the proper capital split/allocation between the long and short in a pairs trade?

There are many different approaches to creating a portfolio comprising long-short pairs trades. Many take the approach of market neutrality. They attempt to create a portfolio that is insensitive to ...
AlRacoon's user avatar
  • 6,642
3 votes

Short sale and zero investmest strategy

You pretty much have this correct. You don’t have to have the spread equal to zero to unwind the trade. All you would care is that the stock you bought (stock A) outperform the stock you shorted (...
AlRacoon's user avatar
  • 6,642
3 votes
Accepted

Pairs Trading situation with spread changes

Of course. Even if you started dollar neutral, the spread can continue to move away from its mean resulting in losses. Pairs trading isn't an arbitrage situation, it simply asserts that given ...
Chris's user avatar
  • 1,643
3 votes

Negatively Correlated Assets with similar medium-term trends

It is very rare to find stocks that are reliably negatively correlated with each other. At least in absolute (as opposed to relative outperformance) terms. It can happen from time to time, but the ...
demully's user avatar
  • 5,081
3 votes

Help with reading currency pairs

The quoting conventions are sometimes illogical for legacy/historical reasons. "CC1/CC2" is usually supposed to mean the amount of CC2 that you'd need to pay to get 1 unit of CC1. CC's are ...
Dimitri Vulis's user avatar
3 votes

Help with reading currency pairs

(Too long for a comment) Having traded spot FX, your knowledge is correct: EUR/USD at 1.0222 means that it costs 1.0222 USD to buy 1 EUR. The first currency is always the base currency, in the sense ...
Jan Stuller's user avatar
  • 6,223
2 votes

Calculate spread for pairs trading

The first method is dollar neutral and the second one is based on the relationship of price movement between two assets. For the first method of dollar neutral Let's say you want to keep the amount ...
vibhu_singh's user avatar
2 votes

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

Whatever correlations appear during a bull direction market (the slow upward grind with rare down days and pallid implied relativity), these correlations undergo deposition to near zero when the ...
FaceInstitute's user avatar
2 votes

Calculating the returns of a long/short strategy

I worked in long-short neutral fund. For a long-short neutral strategy, typically in practice book size is assumed to be long size + abs(short size). So daily return would be daily profit / book size ...
drx's user avatar
  • 21
2 votes
Accepted

Bootstrap Method for Assessing Pairs Trading Performance

Assume on a date t, your pair trading strategy said trade the pair: A and B, say go long A, and short B. By definition of the pair strategy, it is very likely that the price of A declined whereas that ...
Magic is in the chain's user avatar
2 votes

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

As the comments suggest, there is no definitively 'gold standard' of lookback periods for such thing, especially if the underlying distribution appears to be stochastic. I understand where you're ...
Hamish Gibson's user avatar
2 votes
Accepted

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

A more appropriate approach is to sum your PNL each day across all of your positions and calculate the return for the book as a whole (assuming I understand your question correctly). Return should be ...
user42108's user avatar
  • 2,272
2 votes

Should we include constant in linear regression in pairs trading?

Yes For two asset-price processes $Y_t$ and $X_t$ that are both $I(1)$ and cointegrated, the error-term, $z_t$, of the linear regression model, $$ Y_t = \mu + \beta \cdot X_t + z_t $$ is $I(0)$ (see ...
Pleb's user avatar
  • 4,661
1 vote

Cointegration and Ratio Pair Trading

No. In the above equation, you mentioned the spread as the ratio of prices and not of log prices. Also, you verified the spread's cointegration using $A - \gamma \cdot B$ and not $A/B$ as the input ...
Varun's user avatar
  • 31
1 vote

Cointegration and Ratio Pair Trading

If I want to trade the spread, should I model the OLS as $ln(A)=−γ⋅ln(B)+ \epsilon$? It depends on how you define your spread. If you used log return as spread then use log return in OLS also. If you ...
numerairX's user avatar
  • 609
1 vote

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

To find the hedge ratio you can run the Johansen Cointegration test and the eigen-vector corresponding to the largest eigenvalue would give you the hedge ratio, you can see with a bit mathematical ...
Dhruv Mahajan's user avatar
1 vote

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

If two price series are cointegrated, you can run the linear regression to calculate the hedge ratio. The linear regression is in the form: $$y = \beta X + \epsilon$$ where, $y$ is the dependent ...
vibhu_singh's user avatar

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