your money. What is the mathematical definition of a good pair? Equation for going long stock A and short n lots of Stock. One of the best explanations of cointegration is as follows: A man leaves a pub to go home with his dog, the man is drunk and goes on a random walk, the dog also goes on a random walk. What is statistical arbitrage (stat arb)? Requestinisclosure document places YOU under NO obligation AND each document IS provided AT NO cost. Each commodity trading advisor CTA IS required BY THE commodity futures trading commission cftc TO issue TO prospective clientisk disclosure document outlining these fees, conflicts OF interest AND other associated risks. With correlated stocks they will move in the same direction most of the time however the magnitude of the moves is unknown, this means that if youre trading the spread between two stocks then the spread can keep growing and growing showing no signs. Correlation If two stocks are correlated then if stock A has an upday then stock B will have an upday.
Upon coming up with a good fundamental stock pairing you next need to have a mathematical test for determining if its a good pair. From the geometric Brownian motion equation we can see that the expected change in A over time is, in other words A is not stationary assuming isnt zero). When testing for cointegration a hypothesis test is performed, so we can express a level of confidence in the pair being mean reverting. The premise of statistical arbitrage, stat arb for short, is that there is a statistical mispricing between a set of securities which we look to exploit. The best stocks to use in StatArb are those where there is a fundamental reason for believing that the spread is mean reverting / stationary. Prospective clients should NOT base their decision ON investing IN this trading program solely ON THE past performance presented. So in essence the distance/spread between the man and his dog is fixed, also note from the story that the man and dog are still on a random walk, there is nothing to say if their movements are correlated or uncorrelated. AN investor must read AND understand THE ctas current disclosure document before investing.
IN some cases managed accounts ARE charged substantial commissions AND advisory fees. Some examples of fundamentally similar pairs would be Royal Dutch Shell A vs Royal Dutch Shell B shares, Goldman Sachs vs JP Morgan, Apple vs ARM bitcoin mining schwierigkeit (their chip supplier ARM vs ARM ADR, some cross sector groups may also work such as Gold Mining. Sample data is a set of historical data files, and the output is a single correlation matrix and a plot. We want to find a cointegrated / stationary pair. A hard copy OF these risk disclosure documents ARE readily available BY clicking ON each CTA'S "request disclosure document" button. Lets explore cointegration some more: Equation for Geometric brownian motion where A stands for the price of stock. The most common test is to look for cointegration as this would imply that the pair is a stationary pair (the spread is fixed) and hence statistically it is mean reverting. IF YOU ARE unsure YOU should seek professional advice.