Prophet reader “Rob†commented that he was impressed with the SMH:SLV pair so this seemed like a good time to discuss why it’s important to look closer at such apparent high performance trades to understand what’s really going on. Above is the ETF Rewind Pair Analysis showing the characteristics of the pair trades and displaying a very linear and consistent equity curve. Below is the PDQ Dashboard I often use to decipher SMH momentum.
As an aside I’ll mention that I’ve spent hundreds of hours building these various Dashboards and although some ETFs like TLT, GDX, USO, FXE and EEM are very amendable to the Dashboard, SMH is much more problematic and tends to perform best when comprised of relatively non-correlated sectors. But, back to our study….. The last line of the PDQ shows the performance of the SMH:SLV pair over the same time period as the Rewind study above. What’s important here are the results in the “Return %†columns, which clearly show that the bulk of the pair trade profit has been made on the SLV side of the trades. Adding 60 and 14 % = 74%, above the 67% shown on the Rewind study.
This disparity is due to the N days stop that is set on the PDQ and which forces a trade exit if the trade is still open 2 days after the Target Days value. In this way we avoid the prolonged positions that almost always end in a loss. The point of this exercise is to demonstrate that initial performance metrics of pair trades require more than a cursory glance. Hopefully, it will also show how the PDQ Dashboard can greatly facilitate a better pairs analysis. And, for those that have waited patiently for over a year for it’s release…..ITâ€S COMING SOON, complete with an integral real time data feed.
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