Author Topic: Anybody else noticed the change in market dynamics during the past month or so?  (Read 4097 times)

Ray Zhung

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Or is it just me? Granted, my trading is based on the most "archaic" ratio model which has the heaviest reliance on the cointegration of traded pairs. But I've noticed a very prominent trend within my selected pairs (100+ at this point) that, for the past month, of more that half (closer to 75% by my rough estimation) of the trades I made, the pairs drifted further apart after I entered, either the shorted one ascended higher or the longed one descended lower or worse both, in other words the profitability of my strategy turned abysmal. I wouldn't have complained or felt frustrated if it was consistently bad or mediocre, but this under-performance seemingly came out of nowhere. I have been mostly trading the same pairs and using the same entry and exit metrics, and I was able to replicate an almost straight equity cure that goes upright, just like backtests I ran showed, for the first 3 months of so of the year. I reached 5.5+% and a 6+ Sharpe ratio with 0 leverage, and then bam, the whole portfolio started bleeding daily, every week I would have 1 green day and 4 red days it seemed like. Right now my equity curve looks like "亾" and it's not improving, as I'm typing this my portfolio is down 0.6% and this is the fourth red day of the week (today is Thursday).

This got me thinking, could there possibly be a fundamental change in the market dynamics recently? If you think about it, every trade has an opposite trade and the opposite side of stat arb is trend following strategy, in which stocks showed recent strength attract more buyers and the ones showed weakness attract more short interests. If pair trading started to fade that means trend following is gaining traction. I should also mention that I mostly select pairs from the same industry and I look back more than 5 years to make sure they have longer history of cointegration. So when the mean reversion of lot of these pairs started to lose elasticity, that tells us something about this market doesn't it? To me when market participants are more willing to ride on short-term trends that shows that they become more risk-adverse to some degrees, I don't know if this is a valid reason but intuitively it makes sense to me.

I have only started trading this strategy this year I might not know what I'm talking about lol. Anybody with more experience pair trading wants to chime in on this? How is your strategy holding up this year especially the recent month? Is sudden under-performance like this common? Any inputs will be greatly appreciated.

Ray

zilong liu

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My trading strategy is the same!
There's been a loss in the near term , no return status.

Nao Tai

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Any updates guys? 2018 was a good test for most tradings pairs. Any input or tweaks? Trading pairs on the same sectors doesnt help in term of diversification IMO.

Ray Zhung

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Any updates guys? 2018 was a good test for most tradings pairs. Any input or tweaks? Trading pairs on the same sectors doesnt help in term of diversification IMO.

You mean you have your own preset trading universe where most pairs tested good during 2018? If so good for you, I witnessed the opposite where more than half of my pairs disintegrated; or did you filter out some good pairs from the database that tested good during 2018? Well, that's why they got filtered out. In any event, you really can't assess a pair's true profitability until you go live (you can guesstimate).

My own tweaks so far are only applicable if you're using the ratio model: you can only go with the pairs that most of their lookback periods are profitable to trade so that you can minimize out-of-sample risk; secondly you have to constantly add in new pairs and flush out disintegrated pairs, keep your trading universe fluid and dynamic. Don't fall in love with any pair not matter how nearly identical the 2 companies are fundamentally.

If you're doing dollar neutral hedging for each pair I don't think diversification even matter that much. You can have a entire portfolio in the same sector and have lower volatility than having a diversified portfolio with different sectors but some pairs getting way out of whack and causing big losses. Diversification is mostly meant for directional bet which is the opposite of pair trading.

Just a couple of my own nuggets, hopefully more people can share theirs.

Cheers and happy trading.

Stanislav

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Hi All, any updates on 2019 performance - how successful pair trading is now? Has it improved compared to 2018?

Ray Zhung

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Hi All, any updates on 2019 performance - how successful pair trading is now? Has it improved compared to 2018?

From my personal experience, you can gauge the performance of pair trading (besides checking your own portfolio) by monitoring the other side of the trade, which is momentum. When pair trading is not working well, that means mean reversion in general has weakened, and momentum strategies are gaining more steam.

My favorite ETF to look at for such purpose is the AGFiQ US Market Neutral Momentum Fund, ticker MOM. The fund basically takes the exact opposite trades of pair traders' in a dollar neutral fashion. If you check its 2019 performance, there is a mini surge started in May and culminated in early September, then crashed during the month of September. My portfolio had a very good five and half month (up about 7%, Sharpe ratio 4+), then came crashing down during the following month, giving back all the profits. It's 2 years in a row such things happened and I doubt it will be the last. Unfortunately MOM is very thinly traded, so hedging your portfolio with it is not possible. Until there's a viable alternative to hedge your during those momentum surges I just don't see pair trading as a reliable strategy to generate consistent profits.

Ray

Marek

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Hello.  I just joined the forum.  I figured I would comment here since I had some experience with pairs in the past.  I discovered this strategy back in 2008-2009 meltdown.   It was incredible during highly volatile times.  It may be a good reference to go review that time.  I stopped using it but am coming back to it because of the volatility.  I just remember ranges were much wider and as long as vix stayed high, things worked really well.  Something worth looking into.

Hung-Wah Cheung

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My first post. From my personal experience H1 2018 was phenominal and then I experienced a slow grinding decay in H2 2018. 2019 was pretty much a mixed bag. So far in 2020 that trend has continued with some pairs still exhibiting tradeable forecasts whilsts others have bombed.

My extra two cents to not to look for the pairs that everyone else thinks of (KO/PEP) as an example and go for pairs that have capacity constraints. Also look at Japan, though the min lot size makes effective hedging challenging.