- Stationarity, cointegration, and mean reversion
- Pair trading in stocks, ETF’s, futures, and currencies
- Beyond trading pairs: trading stock baskets against index and other statistical arbitrage strategies
Stationarity of a time series
- Concept of stationarity and why it is useful
- Statistical test for stationarity
- Testing for stationarity
- Exercise: Backtesting a possible trading strategy
- Exercise: Testing EURGBP for stationarity
Cointegration of two time series
- Concept of cointegration and why it is useful
- Statistical test for cointegration
- Exercise: Testing for cointegration
- Exercise: Building and backtesting a simple Bollinger Band pairs trading strategy on IGE-EWC
Calculating the half-life of mean-reversion
- How long is the expected holding period for a mean-reversion trade?
- Why is computing half-life better than computing average holding period?
- Using the Ornstein-Uhlenbeck formula to determine half-life
- Exercise: Computing the half-life of mean-reversion for IGE-EWC
The pitfalls of cointegration analysis
- Is cointegration necessary for pairs trading?
- Where 2 instruments are not cointegrated over L/T, but mean-revert under certain situations
- Mean reversion and seasonal effects
- Mean-reversion and trading horizon
“Parameterless” pairs trading strategies
- A way to “pyramid” or “layer” your pairs positions
- What about stop losses?
- Pairs trading stocks, ETFs, and futures
- Which is the best market?
- The pitfalls of each market and some ways to avoid them
Beyond trading pairs
- Trading an ETF against a subset of its component stocks
- Exercise: Constructing a trading model of XLE against its components
- Statistical arbitrage: picking two subsets of stocks from an index & trading them vs each other
- Exercise: Constructing a market neutral statistical arbitrage strategy
- Mean-reversion vs. momentum strategies: why focus on the former?
- Cointegration and mean-reversion: related, but neither necessary nor sufficient
- Different ways to construct mean-reverting portfolios
- Software for download, books and articles for references
APPENDIX MODULE: MATLAB Tutorial
- Why MATLAB and what are the alternatives?
- Overview of its capabilities as a research, backtesting, and automated trading platform
- Exercises: building some utilities for trading and plotting simple graphs
- Using toolboxes
- Freeware: Spatial-econometrics.com