CORRELATION TRADING, PAIRS TRADING, STATISTICAL ARBITRAGE
about CORRELATION, ref : http://fxtrade.oanda.com/currencyCorrelations/index.html
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I SETUP A SYSTEM FOR PAIRS TRADING, EVERYTHING IS COMPLETE, MY ONLY PROBLEM IS ENTRY. FROM WHAT I UNDERSTAND, ENTRY IS BASED ON THE DEVIATION OF THE RATIO OF PAIR1/PAIR2. BUT, ENTRY IS ALSO BASED ON CORRELATION30,90,180,365 TIME FRAMES. FOR EXAMPLE, YOU HAVE CADJPY AND NZDCHF, LETS SAY THEY ALL HAVE CORRELATION GREATER THEN 0.8 ACROSS 30,90,180,365 TIME FRAMES. DO I ENTER WHEN THE RATIO IS 2 STANDARD DEVIATIONS AWAY, AND THE CORRELATION IS BROKEN DOWN(CORRELATION DROPS BELOW ZERO)? I'M CONFUSED ON THIS CONCEPT, I RESEARCHED LOTS OF MATERIAL AND NOTHING HAS SPECIFIC DETAILS ON ENTRY WITH RESPECT TO CORRELATION. FROM WHAT I READ, EXPLOITING WHEN CORRELATION DIVERGES IS THE WAY TO ENTER AND MAKE PROFIT BECAUSE ONE PAIR TRADES UP, THE OTHER TRADES DOWN, LONG SHORT APPROPRIATLY. ON MY SYSTEM NOW, (EA) ENTERS WHEN THE PAIRS ARE MOVING TOGETHER(CORRELATION30,90,180,365 IS GREATER THEN 0.8), I DID NOT SET IT UP TO ENTER ON CORRELATION BREAKDOWN. WHAT ARE YOUR THOUGHTS? DID ANYONE SETUP A PAIRS TRADING EA? WHAT RULES DO HEDGE FUNDS UTILIZE WHEN IT COMES TO CORRELATION BREAKDOWN AND ENTRY?
I ATTACHED AN IMAGE FROM MY SYSTEM, AS THE ARROWS POINT TO RATIO CADJPY/NZDCHF IS 2 STANDART DEVIATIONS AWAY(OVERBOUGHT), WHICH IS ENTRY RULE #1. SECOND ARROWS POINT TO CORRELATION180, AS YOU CAN SEE BETWEEN THE TWO RED VERTICAL LINES, THE CORRELATION BROKE DOWN BELOW ZERO, AND THEN CORRELATION180 WENT BACK TO NORMAL CORRELATION OF BEING CLOSE TO +1.
IS IT CORRECT TO ENTER WHEN CORRELATION IS BROKEN DOWN, AND LONG SHORT APPROPRIATE PAIRS? OR DO I LEAVE MY SYSTEM AS IS, AND ENTER WHEN RATIO IS OVERBOUGHT AND ALL CORRELATIONS ARE GREATER THEN 0.8?