Wednesday, December 23, 2009

EEM / VXX Pair Trade

Today is my birthday and here's my present to regular readers...................
A robust little pair trade that's got a lot going for it.
#1... the N day cycle is 7 days, which produces a typical weekly cycle from entry to exit.. a time frame I like as it contains risk exposure and avoids extended drawdowns.
#2... checking the trade report for the past 6 months reveals no losers and some substantial winners. This is not a one sided PDQ trading approach, but a true pair trade generating gains from both legs.
#3... the equity curve has remained upslope for the backtest period duration and the bounces off the z-score bands have remained consistent without the extended lag we've seen in other profiled pairs.
#4... the EEM/VXX presents an attractive beta spread. 20 day beta on the EEM is 1.93, while the VXX is -2.83. I've found divergent pairs to be much more productive than convergent pairs and although that's a personal preference, I've found the risk/reward ratio easier to control.
#5... for Schwab clients a special can just trade the SCHF commission free as a proxy for the EEM side of the trade.
Check in the archives for my previous correlation alignment study of the EEM and SCHF.


jgpietsch said...

And a very happy birthday to you Bob, Best JP

Kristianson said...

Happy belated birthday!!

Robert said...

You said "I've found divergent pairs to be much more productive than convergent pairs and although that's a personal preference, I've found the risk/reward ratio easier to control"

Can you please elaborate on this a bit more, specifically:
1) why are convergent trades more productive - what characteristics make them so?
2) why is their risk/reward easier to control
3) what was used to generate the 3 dimensional graphic

bzbtrader said...

1. You've got things backward. I've found divergent pairs to be more productive. That's just my bias and may be the product of my tendency to trade visual patterns. For example, using the ETF Rewind software I can immediately see how the equity curve is behaving and react according (mostly using it as a stop). This post was put up in December and if you follow my train of posts to present day you should notice that I use the VIX and VXX almost every day in some capacity to gauge market momentum. The VIX is pretty much the gold standard for divergence and I can only recommend you review some of those posts to follow my thinking.
2. The RR is easier to control (for me) because the fade in divergence is much easier to see than in convergent pairs. Using divergent pairs is like using leverage with the target stock/ETF. Trading convergent pairs is like using reverse leverage. .the changes in character and momentum are harder to detect.
3. This is an Excel chart image.
Hope that helps.

Robert said...

1. Yes, divergent -- whole-word typo
2. Does your preference for divergent pairs apply primarily to those involving VXX or is that in general?
3. What I meant re the chart is what software was used to generate the data points? I somewhat assume this chart shows the performance profile of the system across a range of input combinations.


bzbtrader said...

I do favor using the VIX, VXN and QQV, which is what Project Z is all about. The best results ever achieved on the PDQ Dashboard were as a result of using the VXX. I've mentioned VXX multiple times in recent posts. It has issues all to itself and I'd be loathe to get bullish on it anytime soon.
The topographic charts are a print option with the ETFRewind's Pairs tab. Essentially it's showing how uniform the correlation and N day values are in forecasting divergences or convergences based on the ETFRewind z-score algorithm.

Robert said...

Thanks for the input. Am trying to take my pairs trading knowledge up a level, or twp, so have been reading sites that provide good coverage on the topic. Will go through your archives and will likey have more questions as time passes. Thanks, Robert