Pair trading and multicurrency arbitrage. The showdown. - page 291

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The main mistake made by novice ‘pair traders’ is to choose either the strongest and weakest, or the highest and lowest instruments… so to speak, if they’ve diverged, they’re likely to continue doing so… The key to selecting instruments is to choose converging pairs, roughly 4–6 per cent of the maximum spread between them, to put it simply....
 
By the way – it doesn’t matter where these instruments are on the ‘aggregate chart’
 
Aleksey Nikolayev # :

I also asked about stop-loss. AI's response:

In cointegration and mean reversion strategies, a classic stop-loss of a fixed number of pips for individual pairs doesn't work . If one currency continues to rise and the other continues to fall, your synthetic spread will go into deep loss.
Since you are trading the entire basket as one instrument, the stop loss must be calculated mathematically for the entire portfolio as a whole .
Here are 4 main methods for setting stop losses when trading cointegration:
1. Stop-loss by Z-score (Statistical stop)
This is the most popular and logical method. The deviation of your cointegration spread is measured in standard deviations (Z-score).
  • Trade entry: When Z-score = ±2.0 (the price has deviated significantly from the average).
  • Stop loss: When Z-score = ±3.0 or ±3.5.
  • Logic: The probability that a stationary series will deviate beyond 3-3.5 standard deviations is extremely low (less than 1%). If this happens, cointegration has broken down (the market has changed, and the fundamental links between currencies have been broken). There's no point in continuing the trade—you need to lock in the loss on the entire basket.
2. Time-stop
A stationary spread has a mathematical parameter called half-life . It indicates the average time it takes for the spread to return to its mean value after a deviation.
  • Logic: If the average return time is 24 hours, and your portfolio has been in the red for 72 hours (3 half-lives) and nothing has changed, then the model has stopped working.
  • Exit: All positions are closed at market price after the specified time, regardless of the current financial result.
3. Equity Stop (Money Stop on the Basket)
The easiest method to implement for trading robots.
  • Logic: You calculate the total floating profit/loss (Equity) specifically for those orders that are included in this cointegration portfolio.
  • Exit: If the total loss for all open currency pairs exceeds, for example, 2% or 3% of your total deposit, the robot forcibly closes the entire grid of orders with one button.
4. Stop-loss based on the historical maximum spread
Before starting trading, you analyze the spread history over the past few months.
  • Logic: You find the point of the deepest historical divergence (the maximum peak of the spread in history).
  • Exit: The stop-loss is placed slightly above this historical high. If the market breaks this historical high, the current movement is abnormal and the pattern has broken.
Important rule: No stops inside the basket!
It is extremely important not to set separate stop losses for each currency pair .
Example: If the EUR in your basket rises and the GBP falls, and a separate stop-loss is triggered on the EUR, your hedged contour is completely destroyed. You're left with an open, naked GBP position, which could result in an even greater loss. The basket opens and closes simultaneously (both by take-profit and stop-loss).

Well, there it is, a scientific description of the Sinus method. But everyone weaves their own basket.
 
mvf358 #:
Where is there room here for Roman, the great mathematician whom I banished?

Do you not follow the rules of the Russian language on Fridays?

Roman has taken the theory a step further – dynamic portfolios using the theory of stochastic process filtering.

 
Aleksey Nikolayev #:

Do you break the rules of the Russian language on Fridays?

Roman has further developed the theory – dynamic portfolios using the theory of stochastic process filtering.

We need to focus on developing practical application, not theory, which takes us away from reality. Whenever I asked him to demonstrate his theory in practice and make a profit, he would put on a show and backtrack. For now, his theory remains just that: a theory.
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