Tuesday, September 29, 2009

Qs Pairs Basket - Part 1

This will probably be the final series of posts on pairs for a while.
I will still reserve Tuesdays for pairs profiles and unique pairs situations.
Those that have been with me for a while know that the focus of much of my trading is the Qs in various iterations and in that spirit I'll share my exploration for a viable Qs based pairs basket over the next few days.
Just to jump-start the process I'll show a preliminary Qs matrix (above) as a product of various different recent pair scans that I've been examining. In order to maximize the pairs' correlation threshold I've again set the linearity filter to 90%.
However, I've not set a threshold for P&L returns as each pair needs to be evaluated on its on merits for beta, trade frequency and max daily drawdown per the scatter diagrams I've profiled previously with Gold Digger and other pairs.
I've included EXPD (a stock) as a proxy for the transport index IYT ETF. EXPD actually tracks better than IYT and (at least currently) produces twice the net return of the IYT versus the Qs.
Again, this is a preliminary run only and by the end of the week our basket may have a completely different look and feel.

I've shown two of the Qs matrix pairs analyses to reflect the types of variables I want to include in my Qs basket.
#1 . A variety of optimized (N) days lookback periods and hence a variety of trading cycles.
#2 . A low frequency of losing trades.
#3 . Minimal daily drawdown per the scatter diagram
#4 . High linearity correlation
#5 . A consistency of the equity curve above the R2 best fit slope line.
As mentioned in last Thursday's post, we realistically have to expect that the basket will be a dynamic entity as high correlation pairs tend to be transitory. The basket components therefore are subject to addition and deletion, depending on their performance relative to the R2 slope and a primary goal of this study is the development of an adaptive algorithm that may be updated daily (or more frequently for possible daytrading opportunities) to deliver an optimized Qs pair trading basket.

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