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Spread trading, calculating spread
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Spread trading, calculating spread

  #1 (permalink)
Elite Member
baltimore marylnd
 
Futures Experience: Beginner
Platform: ninja
Favorite Futures: es
 
Posts: 69 since May 2013
Thanks: 1 given, 6 received

Spread trading, calculating spread

Hi guys; call me a dumbass if you want but i got a simple question. what is the formula to calculate spread between ES and NQ?

ES - NQ= pure price spread
ES% return vs NQ%= % spread
ES*50 / NQ*20= spread

I tried googling and there are so many different ways? What is the most common/efficient? I just started reading up on pair trading and would like to create an indicator (that I can share once I create it).

Essentially I want to:

Calculate the spread
Find the mean
Find the standard deviation
Plot them all on a chart
Buy sell when spread is above/below std

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  #2 (permalink)
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  #3 (permalink)
Trading for Fun
Kalispell montana
 
Futures Experience: Beginner
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Curious, are still looking into spread trading?

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  #4 (permalink)
Elite Member
Como, Italy
 
Futures Experience: Advanced
Platform: Tradestation, IB
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I just trade spread with commodities, never tryed index. With commodities I usually just take the spread multipling the instrument with the point value
in your case would be es*50 - nq*20

But I guess all depends to what you are looking for in this spread

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  #5 (permalink)
Trading for Fun
Kalispell montana
 
Futures Experience: Beginner
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Posts: 158 since Jan 2015
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I was looking at using spread to limit risk during the trade.

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  #6 (permalink)
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baltimore marylnd
 
Futures Experience: Beginner
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Hi guys. So here are my findings. It may help someone one day. Or correct me if I'm wrong!

Ratio= Instrument 1 / Instrument 2;

Spread = Ratio - Moving Average of Ratio; // essentially this tells us how far the current ratio value is from it's moving average

z-score = spread / standard deviation

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  #7 (permalink)
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baltimore marylnd
 
Futures Experience: Beginner
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Posts: 69 since May 2013
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hi guys, i'm having a bit trouble conceptually understanding the pair between Gold and SP500. These are both co-integrated pairs and have negative correlation. Co-integration means that historically, the spread between these two expands and then contracts. An expansion follows a contraction, and a contraction follows a expansion. Right now, SP500 has outperformed gold and the spread has expanded. I'm having trouble picking the buy/sell sides of these pairs to profit from the contraction in spread.

Lets say sp500/gc pair has hit a peak and my bet is that the spread is going to decrease. In other words, I am betting that gold will outperform sp500; would I just go long gold and gold sp500, even though these are negatively correlated? And hope that gold prices appreciate more than sp500? Would this be an outright trade? You see, if the pair was sp500/nasdaq, its easy to pick the side because both are positively correlation, so you are essentially going long both or short both and your profit is the spread. But in the case of negatively correlated instruments, how do I set up the trade? THX!

Also if anybody has any good examples of making the pair beta neutral, that would be awsome!

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  #8 (permalink)
Elite Member
Bay Area California
 
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calhawk01 View Post
hi guys, i'm having a bit trouble conceptually understanding the pair between Gold and SP500. These are both co-integrated pairs and have negative correlation. Co-integration means that historically, the spread between these two expands and then contracts. An expansion follows a contraction, and a contraction follows a expansion. Right now, SP500 has outperformed gold and the spread has expanded. I'm having trouble picking the buy/sell sides of these pairs to profit from the contraction in spread.

Lets say sp500/gc pair has hit a peak and my bet is that the spread is going to decrease. In other words, I am betting that gold will outperform sp500; would I just go long gold and gold sp500, even though these are negatively correlated? And hope that gold prices appreciate more than sp500? Would this be an outright trade? You see, if the pair was sp500/nasdaq, its easy to pick the side because both are positively correlation, so you are essentially going long both or short both and your profit is the spread. But in the case of negatively correlated instruments, how do I set up the trade? THX!

Also if anybody has any good examples of making the pair beta neutral, that would be awsome!

With positive correlation you would typically Buy one product and sell the other. With Negative correlation you are Buying or selling both products in the same direction.

"If I agreed with you, we'd both be wrong."
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  #9 (permalink)
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baltimore marylnd
 
Futures Experience: Beginner
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Thanks addchild.

Also what does everything think of the below:

so right now it seems most people, including myself, the way they calculate ratio is:

instrument1/instrument2

the above just doesnt seem to make sense to me as just dividing prices of two stocks do not really tell the entire story, as some stocks have higher tick values, point values and larger average true range. so what does everyone think of the below calculation:

a == (average true range of instrument 1 / tick size) * point value // to get the net dollar move
b == (average true range of instrument 2 / tick size) * point value // to get the net dollar move
c == a/b

for Gold as ES the above plays out as:

a = ....
b = ....
c = 1015/1992 = .5

So basically the above ratio says that on average Gold's dollar move is twice as large as ES. So now we can use the above ratio to give our ratio some weights.

so the final ratio is:

d = ES/(Gold *.5) // here we are essentially trying to make ES and Gold equivalent of one another.. to find days that are wacked out.

What do you think?

and then we can use the above ratio to give weights to the price ratio.

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  #10 (permalink)
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tigertrader's Avatar
 
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you're better off just trading the out-rights and not attempting tp spread the two against each other as there's really no advantage in doing so. if you think you're going to somehow reduce your risk because you're spreading ; think again. also, there isn't any spread margin for that spread and you're going to be incurring more friction because you are going to be paying twice the commissions and experience twice the slippage, especially in the gold. i would first learn how-to trade, period. and then you can play around with spread trading if you wish. but, in the electronic arena, there is really no advantage in doing so. the whole idea behind trading, is making money, and spreading does not afford you the best opportunity for making the most amount of money.

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