Market Summary

The market roller coaster concluded the week on an upward swing propelled by massive injections of cash by the central banks. The extent of these interventions was explained by the WSJ here. For the week, the DJI gained 0.44%, the NASDAQ Composite added 1.34% and the S&P 500 rose 1.44%. This action was welcome and overdue considering the seriousness of the liquidity shortage. It was disappointing that rumors earlier in the week that Fanny Mae and Freddie Mac rules would be loosened were scotched by President Bush on Thursday who said they must complete a ``robust reform package'' before the government will allow them to buy home loans beyond current federal limits. Such a move could have provided relief for the ailing housing market.

Our NASDAQ Market signal reverted to 'enter' on Wednesday after a strong accumulation day (see chart), but we have little confidence that this can be relied upon in the current market turbulence.

By Friday, the Fed futures market was betting on a rate cut at the next meeting of the FOMC on September 18. If this expectation holds, it will be generally good for stocks as bond market yields fall, assuming markets stabilize. The injection of liquidity and a cut in rates would likely have an inflationary effect, however, so it remains to be seen if a rate cut will eventuate considering the Fed's statement on Tuesday that inflation remains their primary concern.

Unilateral Pairs Trading Tool Enhanced

The buy and hold return for the symbol being traded was added to the results summary.

A series of charts showing the inter-relationship btween the two symbols is available by clicking the 'View Analysis...' link:

And a Portfolio Value charts is also available:

Unilateral Pairs Trading - Some Interesting Results

In addition to the enhancements described above, we've started to do some work on the possible results that can be obtained from this trading system. The results are preliminary but show that the system has a lot of potential if the right pair of ETF's are chosen.

We backtested the system for all ETF pairs that had a correlation of at least 0.75 for two time periods: 2001 until the present and for the year to date. The best performing pairs are shown below with the results for QQQQ/SPY for comparison.

Notice that the best profit in 2007 was made largely through shorting. The best return from only going long was by trading EWM against IAH for a total return of 25.49%.

While these results are indeed interesting the pairs that gave the best return do not appear to be logically related. Until there is a rational basis for selecting the pairs to be traded, beyond that they should be highly correlated, there isn't a basis for building a trading strategy. That is the next challenge we will address.

There are two excel compatible files of the backtests if you would like to see them: backtest2000.csv and backtest2007.csv.

Any comments on this strategy would be welcome.

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