RelativeValues Lab principles

RelativeValues Lab principles

event_note 08.03.2019

In today’s post, we are going to look at how the research application’s outputs become a custom application.

The application is planned to be divided into individual modules for each trading approach. Each module will have formalized output defined by given trading strategy: backtest and detailed analysis (with charts and metrics). The user can create own strategy by chosen input parameters.

One of mentioned trading approaches is Relative value, what is based on bets on convergence when the discrepancy between similar or same stocks widens. It means searching for opportunity to exploit from gaps in the price or rate of the same or similar securities. It supposes that the differences are only short-term and the rate of the prices will revert back to original (normal) ratio soon. Relative value funds are perceived as hedge funds as they do not trade the price of a specific security alone and the policy of benefitting from the pricing discrepancies is to buy one security (considered undervalued) and sell the other (considered overvalued) in a form of pairs trading.

The user (fund manager) will build this kind of trading strategy in some basic steps:

According to this universal framework, a lot of questions will rise and the application should allow the fund manager to solve them.

No doubt that the phase of suitable pairs selection is crucial. Potential fund manager has to find two stocks that are similar enough. In the data preparation step of the analysis it is necessary to solve problems like:

Next step in the pairs selection process is to do the proper analysis of prepared data. Here the questions are mainly:

After the crucial step of pairs selection the trading part of the strategy follows. It deals with determination of trading signals, e.g. define rules solving problems like:

Naďa Chalupová