Continuing with our Gold Digger review, here are the trade profiles of the XLE/NEM and DIG/NEM pairs looking back 6 months.
I'm showing the dichotomy between XLE and DIG relative to NEM in order to illustrate the variable performance of a correlated pair based on the leverage offered by Ultra ETFs like DIG.
Note that the optimized lookback period (N) for XLE is 24, while the corresponding (N) for DIG is 15. The implication is that the NEM/DIG pair will trade with a higher frequency and, other things being equal, produce a higher net return.
Before we decide that the NEM/DIG pair is the better option, we need to look at the daily drawdown and max possible lost over our test period.
Keep in mind that we also need to keep an eye on how the hypothetical P&L (equity curve) is riding along the R2 slope. Once the equity curve falls below R2 the safest course of action is to not trade the pair until the equity curve resumes precedence to R2.
This risk management approach is the key argument for using a basket of pairs as profiled yesterday as the performance of the equity curve relative to R2 will most often be out of sync among components of the pairs basket.
Having looked at a few hundred of these pairs over the past 2 weeks, one attractive characteristic of the NEM/XLE and NEM/DIG pairs is the clarify of the Z-score reversals as shown on chart C. In most cases the turns are signal events with little slippage or redundancy.
The DIG pairs does produce a shadow trade on 5/4, but this should be considered an opportunity to re-enter or scale further into the 4/18 signal.
Tomorrow we'll look at what risk control advantages the embedded Trade Report (lower right below chart D) can provide.