ArbMakerPlus analyzes long/short pairs that have positive beta but also does the same for those with negative beta.
Below is a 1 minute plot of the forex pair EURSEK/SEKJPY showing the residuals Z-score and price. The pair is notable in 3 ways:
- The beta is -0.569 with a strong R² of 96.9%
- The absolute value of the beta means the pair will not be dollar neutral: a $1 move in SEKJPY accompanies a drop in EURSEK of $0.569
- There is a common currency, SEK, on both sides of the pair
The implication of the second point is that a beta that is also low in absolute terms means will, if it alters significantly during a trade, cause the larger dollar half of a pair to disproportionately impact the P&L. Although ArbMakerPlus re-calculates beta with incoming data this can still occur. The effect is most pronounced with leveraged instruments: leverage will significantly magnify the impact of any deviation from the modeled statistical relationship.
The third point indicates that with a common factor in a FX pairs trade the residuals charts (Z-score and Bollinger Band versions) are effectively presenting a third, single, instrument – a sort of ‘triplet’ if you like. In this example it is EURJPY that offers the alternative trading option.
The chart below presents additional information on the pair with, perhaps most importantly, the Indexed Prices & Spread graph showing the relative price movements dictated by the low absolute beta relationship; and also the negative correlation implied by the negative beta.
This pair was back tested using the “Multi1” strategy which is available for download on the Take the Trial page. The data used by ArbMakerPlus came from IQFeed.