Hi

Cointegration is not easy to prove but not difficult either. Two time series are cointegrated if a LINEARLY WEIGHTED COMBINATION of them is STATIONARY. Individually, financial time series CANNOT be stationary due to the presence of TRENDS. (Actually, this brings us on to the most interesting part - how do you identify a trend?)

So start with your two currencies. You can do a Dickey-Fuller test on each (not hard in Excell - see previous posts) to prove to yourself that they are non-stationary. Then run various linear combinations. There are various methods but trial and error is easy on a computer. If you use 1% increments, e.g. 99%A + 1%B, 98%A +2%B, 97%A + 3%B etc you will only need 100 tests. At each combination, do a Dickey-Fuller test and test for the presence of a unit root.

IF you find a co-integrated pair you are very lucky and can exploit this for all it's worth! Wait until the pair wander apart then go long one and short the other. MAKE SURE THE HEDGE RATIO IS CORRECT!! If you do this right, you cannot really lose and long-term they will re-converge and you will gain on both the long and short leg.

This was how I bought my new car a couple of months ago.

CB

Cointegration is not easy to prove but not difficult either. Two time series are cointegrated if a LINEARLY WEIGHTED COMBINATION of them is STATIONARY. Individually, financial time series CANNOT be stationary due to the presence of TRENDS. (Actually, this brings us on to the most interesting part - how do you identify a trend?)

So start with your two currencies. You can do a Dickey-Fuller test on each (not hard in Excell - see previous posts) to prove to yourself that they are non-stationary. Then run various linear combinations. There are various methods but trial and error is easy on a computer. If you use 1% increments, e.g. 99%A + 1%B, 98%A +2%B, 97%A + 3%B etc you will only need 100 tests. At each combination, do a Dickey-Fuller test and test for the presence of a unit root.

IF you find a co-integrated pair you are very lucky and can exploit this for all it's worth! Wait until the pair wander apart then go long one and short the other. MAKE SURE THE HEDGE RATIO IS CORRECT!! If you do this right, you cannot really lose and long-term they will re-converge and you will gain on both the long and short leg.

This was how I bought my new car a couple of months ago.

CB