Friday, September 11, 2009

GE/XLF GE/FAS Pairs

Today's pairs study is a little departure as it reviews how GE (a stock) trades against XLF versus its steroids driven version FAS.
Those who have followed me for a while know I actively trade GE, one of the very few stocks that I include in my portfolio.
I like GE as a trading vehicle for several reasons.
...It's a close proxy for overall market momentum and sentiment built into one product.
...It's a financial and a tech stock, although more responsive to the financials than tech.
...It's got tremendous daily volume, often exceeding the Qs.
...The NYAD tracks GE like radar and I've posted several studies under the HOW I TRADE right blog panel.
...GE reacts positively to VIX crosses on 1 & 2 minute bars as shown on the VIXEN studies.
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Just to establish a pairs correlation between GE and the financials I ran XLF as a acid test, with a resultant correlation and P&L both in the mid 80s . . a good risk/reward IMHO. The optimized trade cycle period is 17 days, a little long for my comfort level, but that's just me.
When applied to shorter time frames such as 10-60 minute bars, the trading landscape changes considerably to the favorable.
Fast forward to the GE/FAS pair. These prospects really look encouraging as we now have 100% correlation and a handsome 262% P&L. Perhaps as expected, the trade volatility (frequency) has been compressed to 2 days. I like that.
As with the GE/XLF model additional testing of shorter term time frames is required to validate this pair as a viable daytrading application. The possibilities are . . interesting, to say the least.

6 comments:

Alberto said...

Bob,

This pair suffers from the same problem I pointed out yesterday. By trading GE/FAS as a dollar neutral pair you are overexposed on FAS side because it is a 3 times leveraged ETF. If you do a trade report on the pair you will notice that in approximately 60% of the trades you are long the FAS. Whenever the trade sets up that way you will generate triple the P&L.

Al

bzbtrader said...

Alberto,
I agree with your point, which is why I ran the XLF/GE pair test first.
My ongoing goal is to develop a basket of indicators to reliably trade GE, just as my ongoing goal is to develop a basket of indicators to reliably trade the Qs. If I find that a basket of GE pairs setups produce consistently aligned signals by comfort level in trading GE, either up or down is substantially increased. The XLF/GE and FAS/GE trade signals represent potential components of such a basket to me.

Alberto said...

Understood. In that case it appears that if you were to put GE in the "A" spot and then check the option in the lower right corner to trade unpaired you would get the resulting P&L from GE trades only. This would likely be the useful figure.

bzbtrader said...

Alberto,
Running GE as Ticker A Only produces pretty dismal results in terms of P&L and/or trade frequency, in turn suggesting that the bulk of the money in this pairs model is made on the XLF/FAS side.
Next week I'll run an in depth series on NEM and KRE to try and expand on the basket concept I mentioned in the earlier comment.

Alberto said...

I figured it would be. Reason being that the market has been going up for the last six months (which is the test period) and the pair is suggesting that you trade equal dollar amounts of GE and a triple long ETF. Like I was saying before, it just happens that during the test period you would have been long the FAS 60% of the time. If you were short $10,000 of GE and it was up 1% you would be down $100 but if you were long FAS and the financials were up 1% would would make $300 because of the 3x leverage of the ETF.

jgpietsch said...

Hi guys, good discussion. Again, agree w/ Alberto re mixing and matching leveraged products. I think the XLF pairing makes sense though. To really make it sing, try the 'switch on first signal' option. Yes, part of what you are capturing is the beta disparity even 1:1, as XLF has recently worked well on its own. Best, Jeff