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Trading the cointegration

  • #1
  • First Post: Jun 10, 2012 4:28pm Jun 10, 2012 4:28pm
A few words first:
Two or more time series are cointegrated if they share a common stochastic drift(wikipedia).Practically,this means that their residuals are mean-reverting.
This method can be used for any two(or more) time series,whether these are forex,stocks, etc,as long as they are cointegrated.

Cointegration trading has been used excessively in the past decades by hedge funds and banks.This means that,if used properly,it can be a very powerful tool in our trading arsenal.

There have been many threads so far discussing ways to trade using cointegration.I have read many of them but i havent found yet any where a solid method is developed. And this is due to the fact that it hasnt been tested which pairs are cointegrated and which are not.

This is where this thread will emphasize.On ways to test for cointegration and how we can use it to trade.

To the main point now:
There are 3 programs that i know of that can be used to check whether two time series are cointegrated:
Matlab:Probably the best of them.This is used by the pros.Unfortunately it requires extensive technical and mathematical expertise and training that i dont have.I would be happy to have someone posting here that knows how to use Matlab and maybe can help us.

R:This is the software that has been used in the most threads that discuss about cointegration.It is the only on that is free.It also requires some programming skills.I dont have these skills and for this reason i find it a bit difficult to use as i dont know how to check for cointegration,do backtests etc.If you want to learn more about it and how to trade with it please refer to this thread:http://www.forexfactory.com/showthread.php?t=363198

Arb-maker:This is a new and constantly developing software that focuses exactly on how to trade using cointegration.Unfortunately,it isn't yet as developed as Matlab is,but it is extremely user-friendly and is probably the best choice for people with no programing skills like me.I will use this from now on to run my tests,post charts,develop my strategy etc.

This is all for now.Tomorrow,i will write about the exact strategy i will follow and i'll probably attach a trading explorer as well.
  • #2
  • Jun 11, 2012 5:26am Jun 11, 2012 5:26am
The strategy i will follow is simple.
I will use mainly the 15min timeframe and occasionally the daily one and i will use 2500 data points to check for cointegration and plot the z-chart.
I will enter the trade when z>2.1 or z<-2.1 and close if the trade goes 6% against my position.
I will close with profit at z=0.4 if i take the trade at z=-2.1 and at z=-0.4 if i take the trade at z=2.1.
It looks easier with a chart.
I will also take one trade at a time and initially i'll only trade micro lots.
The good thing about arb-maker is that it does everything for you.You just have to take the trade.
Let's start.
  • #3
  • Jun 11, 2012 5:29am Jun 11, 2012 5:29am
Quoting eremix
The good thing about arb-maker is that it does everything for you.You just have to take the trade.
This is great news.It means the guy I walk past every morning can then become a millionaire with just a computer and the arb maker. Right?
Time hides Nothing
  • #4
  • Jun 11, 2012 5:53am Jun 11, 2012 5:53am
First trade:
This is what the cointegration test gave me .USDCAD/GBPUSD seems nice.It is cointegrated on both levels and it generally has good test statistics(high R,etc).
I bought 0.01 lots on both pairs.
http://img269.imageshack.us/img269/7218/78765183.png
  • #5
  • Jun 11, 2012 6:40am Jun 11, 2012 6:40am
Quoting CindyXXXX
This is great news.It means the guy I walk past every morning can then become a millionaire with just a computer and the arb maker. Right?
I didnt say that.I never claimed that you can become a millionaire with just a program and a computer.I just said that everything you need in order to trade the cointegration it can be done using this.You still have to pick carefully your trades and manage them correctly,have some experience and read the fundamentals.I's just another way of trading.You can use any of the 3 programs that i posted above.I just prefer to use this because i have no programing background.It's not magic afterall,it's statistics.
  • #6
  • Jun 11, 2012 7:01am Jun 11, 2012 7:01am
Ok,here is the trade.I hope the strategy is clear.

http://img7.imageshack.us/img7/6823/62363339.png
  • #7
  • Jun 11, 2012 7:02am Jun 11, 2012 7:02am
Quoting eremix
I didnt say that.I never claimed that you can become a millionaire with just a program and a computer.I just said that everything you need in order to trade the cointegration it can be done using this.You still have to pick carefully your trades and manage them correctly,have some experience and read the fundamentals.I's just another way of trading.You can use any of the 3 programs that i posted above.I just prefer to use this because i have no programing background.It's not magic afterall,it's statistics.
Just checkin'.... Sounds kind of interesting..
Time hides Nothing
  • #8
  • Jun 11, 2012 7:30am Jun 11, 2012 7:30am
Quoting eremix
The strategy i will follow is simple.
I will use mainly the 15min timeframe and occasionally the daily one and i will use 2500 data points to check for cointegration and plot the z-chart.
I will enter the trade when z>2.1 or z<-2.1 and close if the trade goes 6% against my position.
I will close with profit at z=0.4 if i take the trade at z=-2.1 and at z=-0.4 if i take the trade at z=2.1.
It looks easier with a chart.
I will also take one trade at a time and initially i'll only trade micro lots.
The good thing about arb-maker is that it does...

How are you computing your z-scores? Please post the code for the script/indicator/matlab/R file. Thanks! I have been doing matlab and R cointegration tests and have found it difficult to streamline the process with MT4. I have tried DDE connection and CSV files, with CSV files being more easy to get working at the moment. I would be interested in hearing how you have been doing this. Do you mind sharing?
  • #9
  • Jun 11, 2012 7:46am Jun 11, 2012 7:46am
Quoting mwduke
How are you computing your z-scores? Please post the code for the script/indicator/matlab/R file. Thanks! I have been doing matlab and R cointegration tests and have found it difficult to streamline the process with MT4. I have tried DDE connection and CSV files, with CSV files being more easy to get working at the moment. I would be interested in hearing how you have been doing this. Do you mind sharing?
As i said before,i have no programing skills.For this reason i can use neither Matlab nor R to run cointegration tests and plot the z-chart.I use arb-maker.I only use Metatrader 4 to open and close trades.
  • #10
  • Jun 12, 2012 6:28am Jun 12, 2012 6:28am
  •  sym
  • Joined Apr 2011 | Status: Working... (too much) :) | 356 Posts
Quoting eremix

Arb-maker:This is a new and constantly developing software that focuses exactly on how to trade using cointegration.Unfortunately,it isn't yet as developed as Matlab is,but it is extremely user-friendly and is probably the best choice for people with no programing skills like me.I will use this from now on to run my tests,post charts,develop my strategy etc.
Hi eremix
nice thread, I'll follow it...

unluckily arb-maker isn't cheap, actually is expensive.
I'd like to make research among pairs, but I need something else.
--- nothing to say ---
  • #11
  • Jun 12, 2012 6:55am Jun 12, 2012 6:55am
Quoting sym
Hi eremix
nice thread, I'll follow it...

unluckily arb-maker isn't cheap, actually is expensive.
I'd like to make research among pairs, but I need something else.
Yeah,about that...R is the only one that i have found to be totally free.If you know how to make it work and you like it than go for it.
On the other hand,if you have no programing skills than you have to take arb-maker as an investment.
Afterall,you'll use it to make money.
Think about it.You can't make any money without investing something.
With arb-maker you'll invest the money to buy it plus your trading capital.
If you are a techincal trader you'll invest the time to learn how to trade techincally(and believe me time=money) plus your trading capital.
Even if you work in a coffee shop as a waiter,you still invest time.TIme that could be used to do something else and make money.
It's called opportunity cost....and believe me,it's not negligible.
So as i see it,you have 2 choices.You either downlaod R and try to learn how to use it as fast as you can,investing your time and the opportunity to make money or you download arb-maker,you demo trade for a week to learn how to use it and then you try to make money.
I chose the latter one.

As for the trade i opened yesterday,it's going pretty well.z=-0.4 and i've made 38 pips so far.I'll post a screenshot when i'll close it.I hope it will hit my target.
  • #12
  • Jun 12, 2012 7:05am Jun 12, 2012 7:05am
  •  sym
  • Joined Apr 2011 | Status: Working... (too much) :) | 356 Posts
Quoting eremix
Yeah,about that...R is the only one that i have found to be totally free.If you know how to make it work and you like it than go for it.
On the other hand,if you have no programing skills than you have to take arb-maker as an investment.
Afterall,you'll use it to make money.
Think about it.You can't make any money without investing something.
With arb-maker you'll invest the money to buy it plus your trading capital.
If you are a techincal trader you'll invest the time to learn how to trade techincally(and believe me time=money) plus your trading...
Good luck with your trade

I think I'll use R, I have some programming skills so it's wise for me (try) to use them.
I downloaded arb-maker as well, but 14 days are gone.
I think there are other "visul empirical methods" to find cointegration... but still numbers are better.

thanks


P.S. I'm running NZDUSD/CADUSD for the second time in 2 days. First one profitable, second one in DD (but I can wait)
--- nothing to say ---
  • #13
  • Jun 12, 2012 7:24am Jun 12, 2012 7:24am
Hmmm, eremix, this Arb-Maker looks like a useful tool. I think I'll sign up for a trial.

I wish it's as good as it sounds ... Arb-Maker ... yeah ... this is not the funniest product name tho. I had an original aussie made Orgasmatron. A battery operated Trembler, actually. It's NOT what you think it is. It's a head massager

Thanks again!
forget about tomorrow, just steal away into the night
  • #14
  • Jun 12, 2012 9:59am Jun 12, 2012 9:59am
I love how none of the residuals are stationary - arb, right....
  • #15
  • Jun 13, 2012 6:45am Jun 13, 2012 6:45am
Quoting Rikers
I love how none of the residuals are stationary - arb, right....
I dont understand what you mean.Have you tried it and found no cointegration at all?
  • #16
  • Jun 16, 2012 9:14am Jun 16, 2012 9:14am
Ok,i 've decided to close my trade because of the upcoming greek elections.
Z=0.2 and my profit is 150 pips at the moment.I am not willing to have open trades this Monday.Take a look at the huge move GBPUSD made....like magic.

http://img85.imageshack.us/img85/1543/exitz.png
http://img829.imageshack.us/img829/8...pusdusdcad.png
  • #17
  • Jun 16, 2012 9:46am Jun 16, 2012 9:46am
Quoting eremix
I dont understand what you mean.Have you tried it and found no cointegration at all?
Yes, this is not cointegration....and I've tried analyzing cointegration on several pairs and there is no long term cointegration

there's more of a lead lag short term correlation
  • #18
  • Jun 16, 2012 9:55am Jun 16, 2012 9:55am
Quoting Rikers
Yes, this is not cointegration....and I've tried analyzing cointegration on several pairs and there is no long term cointegration

there's more of a lead lag short term correlation
Could you please explain?Why is it not cointegration?How did you analyze cointegration?
I agree that there are very few currency pairs that are cointegrated in the long term.
But you can exploit short-term extremes like that.
  • #19
  • Jun 17, 2012 2:56am Jun 17, 2012 2:56am
Quoting eremix
Could you please explain?Why is it not cointegration?How did you analyze cointegration?
I agree that there are very few currency pairs that are cointegrated in the long term.
But you can exploit short-term extremes like that.
Because if there is no long term cointegration you can always overfilt so the coefficients produce short term cointegration on the last time segment you look (most recent). This is similar to spurious regression (this is very common in Fx because of the correlation in the movement of Fx pairs).
  • #20
  • Jun 17, 2012 5:31am Jun 17, 2012 5:31am
Quoting Rikers
Because if there is no long term cointegration you can always overfilt so the coefficients produce short term cointegration on the last time segment you look (most recent). This is similar to spurious regression (this is very common in Fx because of the correlation in the movement of Fx pairs).
Ok,but i dont understand how this is bad for our trading.Since we can find coefficients that produce short term cointegration,why cant we exploit that?
Anyway,i've also tested the exact same strategy over a period of 5 years in pairs that are not cointegrated at all.Same results,nice profit.
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