Statistical arbitrage and pairs trading on Forex

Statistical arbitrage

1. About

Statistical arbitrage - is the mispricing of any given security according to its expected value, based on the mathematical analysis of its historical valuations. Statistical arbitrage is often involved with pairs trading.

A statistical arbitrage pairs trading position consists of a long position on one security and a short position on another security. On the forex market, we should open a long position in an undervalued currency pair and a short position in an overvalued currency pair.The profit will get during the moving currency pairs to their mean price.

For trading, we should use pairs with strong correlation and cointegration. Moreover, the change in the distance between these pairs must be stationary.


2. The main idea of the strategy

We must find such currency pairs that move in the same direction and have a strong relationship - correlation.
The correlation coefficient must be greater than 0.9.

Temporary divergences often occur between these currency pairs. The presence of such discrepancies can be identified using the coefficient of cointegration.
It should be no more than 0.05.

For example, currency pairs audusd and nzdusd. These pairs have strong correlation (0,97) and cointegration (0,00132).
Most of the time, these pairs move in sync, but sometimes there are small price divergences between them, which then quickly level out.

The purpose of the strategy is to find such moments of divergence between pairs and use them in trading.



3. How to determine the moment of divergence of currency pairs

To determine the moment of divergence of currency pairs, a synthetic value is used, which is called the spread.

The spread reflects the relative difference between the change in the values of currency pairs. The average value of the spread over a certain period of time is calculated by the linear regression formula using machine learning algorithms.

If the spread value deviates by more than 2 standard deviations up or down from its average value, this is a trade signal.



4. Real Time Dashboard

To determine the correlation, cointegration and stationarity of the spread, I use the dashboard. It is free for everyone.

Link: forexpairtrading.com

5. Telegram channel with signals

For your and my convenience, I launched a telegram channel.
When a trading signal appears, the bot sends a message to this channel.

LINK to telegram channel




6. YouTube channel

I talk more about this strategy with examples of transactions on my YouTube channel. Subscribe.

Link to my youtube channel.

7. Trading panel

To make trades, I use the trading panel for the MT4 terminal.
Open two charts and tile them horizontally. Pair 1 set on top and Pair 2 on the bottom.

Magic - unique number for orders.
Pair 1 - set Pair 1 name like in your terminal.
Pair 2 - set Pair 2 name like in your terminal.
Profit in % - TP in % from account balance (summary profit from your orders (profit/loss Pair 1 + profit/loss Pair 2 + comissions + SWAP).
Loss in % - SL in % from account balance.
Trade amount in % - this is the position size in the deposit currency. For example, depo is 1000$. Trade amount = 10%. The money size for Pair 1 is 100$, and the money size for Pair 2 is 100$.
Lot coefficient help to tune the total trade amount in $.
Font size is tune letters size on buttons.
Slippage in pips - value for accounts with instant order execution.

Position open
If you want to BUY Pair 1 and SELL Pair 2 - press BUY button.
If you want to SELL Pair 1 and BUYL Pair 2 - press SELL button.
If you want to close positions - press CLOSE button.

Link to trading panel

Link to SET file (recommended settings)


Subscribe to my thread!

Nice trading strategy you have. Great work on your website with the charting. I'll keep a close eye on this.

Is it possible to have the hours on the x axis of the charts so we can back test the strategy?

Your comment 'If the p-value is less than 0.05 - these pairs are good for trading' is this the most optimal value you have found for trading these pairs? And when your talking about p-value you mean the percent change difference between pair 1 and pair 2 on your 'Percent Change Chart'?

So at present from the list of pairs that you trade only the 'EURGBP : EURAUD' and 'AUDUSD : GBPUSD' pairs are presently just outside of p-value 0.5. So if they drop to p-value 0.5 or less you would look for standard deviation of 2 or -2 on your spread deviation chart before looking for setup.

Hi Analiteg,

thanks for opening this thread.

A question: the x-axis in your charts shows numbers in thousands? Would it be possible to show the date/time instead?

Hi!
This is the number of minutes. I use minutes data for charts and calculations. To use date/time format is inconvenient, because of gaps on charts (weekends and holidays). There are some limitations in the chart engine.

Hi
Is it possible to test this approach?
If yes, do you have any historical performances?
The approach you described sound logical and it's mathematical based for numbers lovers

Hi!
You can see my trade explorer. I use this strategy.
Now I have described only the idea, a little later I will describe in detail how I trade and what and how I use it.

Hi, Mark.
p-value is statistical value. Two time series are cointegrated if the p-value is less than 0.05.
We should trade only cointegrated pairs.

My today trades

Thanks

Thanks for this thread. How much spread is allowed for this strategy to make sense? What's your opinion?

Hello Analiteg,

I noticed that you use the same lot size for each pair trade. But shouldn't the lot size be adjusted individually? I noticed that that is normally applied in spread trading strategies.

What is the SL / TP you use in this kind of trading?

And finally, could you include in the dashboard also US30 and US500, as well as futures?

Thanks

Lopau

Hello Analiteg

In the 2nd step of the process, you mention:

Look at the second chart Spread Deviation.
If, the Spread deviation is greater than 2 wait until it became less than 2. Then, you should SELL Pair2 and BUY Pair1.

Should it not be the other way round? That is if the spread deviation is greater than 2, then sell pair 1 and buy pair 2

Do we just buy or sell any time them numbers hit like that or is there a strategy to know when to buy or sell inside this idea

Hi, kofix11!
Which type of spread do you mean? Spread between currency pairs, or spread from your broker?
For good results, it will be good to have a lower spread from your broker. Spread from my broker starts from 0 on major pairs. I can recommend my broker, write me in private messages.
If we talk about the spread between currency pairs, usually I have a profit of 7-10 points.

I will tell you about lot size, TP, and SL a little bit later.
As for US30 and US500, I plan to include them in some months.

No, it is all right.
The spread formula is Spread = Pair2 - x*Pair1.
So if the spread moves from 2 to 0, it means that Pair1 rates grow and Pair2 rates decrease.

Yes, we need a strategy to trade inside this idea. I will tell you about it today.

Strategy

There are two styles of stat arb trading - scalping and swing.I personally use scalping and recommend it to you. In scalping, you can get 3-5 trades per day. But as for me, 1-2 trades per day is enough.

My settings

Date Range - by default (20 days).

Currency pairs for trades (Pair 1 and Pair 2 respectively):

1. EURUSD and EURJPY
2. EURGBP and EURAUD
3. AUDUSD and GBPUSD
4. GBPUSD and GBPJPY
5. GBPCHF and GBPJPY
6. GBPCHF and GBPUSD
7. USDCHF and USDJPY
8. EURUSD and EURCAD
9. EURUSD and XAUUSD

I prefer major pairs with a lower spread.I start checking these pairs. It is important that p-value should be less than 0.05. Sometimes I admit 0.06.

Spread Deviation

We have borders: 2 and -2. There are standard deviations from the mean. It means that spread usually moves from these borders to the mean. Usually, but not always. We should wait until the spread starts to move from this border to the mean.

For example, if the spread is 2.3, wait until it becomes 1.95 and then SELL Pair2 and BUY Pair1.

Sometimes, the spread can be very high: 3 or -3 and more. In these cases, I usually wait until the spread becomes lower than Spread Deviation MA 20. After this, I open trades.

Positions open

For positions open, I usually use the trading panel for MT4.
This panel automatically opens trades on currency pairs, calculates lot size, and automatically closes trades.

How to use the panel

Open two charts and tile them horizontally. Pair 1 set on top and Pair 2 on the bottom.

Settings

Magic - unique number for orders.
Pair 1 - set Pair 1 name like in your terminal.
Pair 2 - set Pair 2 name like in your terminal.
Profit in % - TP in % from account balance (summary profit from your orders (profit/loss Pair 1 + profit/loss Pair 2 + comissions + SWAP).
Loss in % - SL in % from account balance.
Trade amount in % - this is the position size in the deposit currency. For example, depo is 1000$. Trade amount = 10%. The money size for Pair 1 is 100$, and the money size for Pair 2 is 100$. Panel calculates which lot size you can open for Pair 1 on 100$ with leverage 1:100. For USDJPY panel opens 0.1 lot.
Lot coefficient help to tune the total trade amount in $. For example, if lot coefficient pair1 = 1.1 it means that the money size for Pair 1 is 100$*1.1 = 110$ and lot size is 0.11 lot.
Font size is tune letters size on buttons.
Slippage in pips - value for accounts with instant order execution.

Position open

If you want to BUY Pair 1 and SELL Pair 2 - press BUY button.
If you want to SELL Pair 1 and BUYL Pair 2 - press SELL button.
If you want to close positions - press CLOSE button.

My settings

 

1. Profit in % = 3
2. Loss in % = 15
3. Trade amount in % = 10
4. Lot coefficient pair1 = 1
5. Lot coefficient pair2 = 1
6. Account leverage = 1:1000

The panel automatically closes positions when total profit is greater than 3% from the account balance or total loss is greater than 15%. I use SL as a defense against unforeseen situations. If you got an SL it means that you have made something wrong in your analysis.

Thanks for clarification, I thought the formula was
Spread= Pair1-x*Pair2