Correlated Currency Divergence Arbitrage

Trading Systems
1

Hello Traders,

I’m a new trader and I have a strategy that I want to to share with you to have an opinion from experienced trader, and in case some of you will help coding the indicators required.

Basically Correlated Pairs (Gold / Silver) (S&P / Nas) (…) move like DNA strands: they will cross each other, and then they will move away one from another like an elastic, to move together again later, and this sequence is repeated over time.

How can we take advantage of this sequence?

When they are far away from each other, at the maximum extension of the elastic, we can Sell the one above and Buy the one below.

No matter what, they will later cross each other again, and we will close both the position at the crossing.

At the closing we will have 3 scenario:

  1. If the cross occurs between the Buy and the Sell, both trades are in profit.
  2. If price closes above the Sell, the Buy will be in profit and Sell in loss, with the profit of the Buy bigger than the loss of the Sell.
  3. If price closes below the Sell, the Sell will be in profit and the Buy in loss, with the profit of the Sell bigger than the loss of the Buy.

So, no matter where the price closes, we will have a NET position of the 2 positions in profit.

Basically it is like an arbitrage on the divergence of correlated pairs.

A drawdown may occur after we place the trades, if the elastic enlarge even more, so we will have for some time a drawdown. In this case we may also think to add a position as no matter what, the 2 pairs will cross each other again later.

It can be used on any time frame. I expect more trades on smaller timeframe with small profit (smaller pips) each, and I expect fewer trades on bigger timeframe, but with bigger profit (bigger pips) each.

What we will need?

  1. We will need an overlay indicator which put the 2 pairs on the same chart.
  2. We will need an indicator which indicate something like the strength of the divergence, which will help us to filter and to place the 2 trades at their maximum extension. For example, if this indicator has a scale of 0-100, we may consider to place the trades everytime the indicator goes above 80. You are more experienced, so my question is: “Do you have any idea how this divergence strength indicator can be achieved? Which formula?”
  3. We will need a calculator which give us the equivalent position sizing of the trades to be placed for the 2 pairs.

If you kept the time to read my post I would love to hear your thought? But most important, do you believe it can it be done?

Thanks in advance for answering.

2 Likes
2

What can I say … Good luck :slight_smile:

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I think this is a great idea. I’ve experimented with this on and off in the past, most recently using AUDUSD and NZDUSD. I never dove too much into it, but I used MT4 and just put the charts side by side. When the daily bars closed I would watch to see if 1 closed negative and the other closed positive against the USD. Obviously, this didn’t give me very many opportunities, but I did get a couple and made some profit off the trades.

I’m thinking a good indicator might just be a moving average. Stick a 200 MA on there and measure the distance price is from the moving average at closing. Much like Dennis’ SW thread, you can find the formula there to calculate it manually.

I also use a indicator for stocks on TradingView that measures the distance price is from the MA, just google “distance from moving average” and you’ll find a few different ones.

Good luck!

2 Likes
4

Thank you for your reply.

I didn’t understand thou how you mean to use the moving average.

I need the indicator to tell me if the elastic extension reached is good enough to place trade. In order not to go into drawdown too much.

That’s why I asked some suggestion to measure the strength of the divergence.

You are suggesting to use 200 MA. But I don’t understand how to use it. Can you make an example, please?

More over I guess 200 MA would be good to trade on the daily timeframe, but as you said, there won’t be too much entries.

I was thinking to use it more from the 5 to the 30 minutes timeframe. Probably less pips gained each trade but more frequent trades, like the arbitrage.

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Innovative hopes it make you money mate

1 Like
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ok @Orion80 just to be clear. Arbitrage, HFT ( High Frequency Trading ), Scalping, these trading methods are using by hedge funds and investments banks with millions / billions of capital, they have knowledge, infrastructure, and of course funds to do it properly. How you will imagine trading in this field?

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Well @Profesorpips…

I’m not sure that you know what knowledge means. You just throw it in this post to make it sounds more professional.

If you want to succeed in any field, trading included, you must be aware that you can achieve all the knowledge required if you want.

I described a strategy and that’s all the knowledge required to apply it.

And i remind you that with today technology everybody can achieve High Frequency Trading from the laptop in your room.

You also mention millions of capital required in your post. Do you know the magic of trading? It is that if you can make 100 you can make 1000 thousand, if you can make 1000 you can make 10000, and so on…

If you read some biographies of successful trades, you will know that they all started small.

The way you speak of the money of the investment banks and founds make me feel you think they are the evil and that you just dream some of their money but you never took what it takes to get your slice of the pie.

My suggestion before making such out of place posts is to go and read for example “Market Wizards Books” to get some enlightenment.

I simply posted my strategy idea if you have some constructive/destruction opinion in this format:

In my opinion it may work for X/Y/Z reasons.
Or
In my opinion it may not work because didn’t consider spread. Or because the divergence wouldn’t be enough big to have a margin. Or your assumption is wrong because in my experience chart can diverge for such long time that drawdown would be too much.

I mean, any constructive critics would be accepted.

But not some word throw in air as fried air…

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you know what @Orion80 ? you are right, I should comment every aspect of your trading strategy because you are written very nice post, and you are new on the forex market, I should give you every information “on the plate”, but you are so smart… you will handle with all aspects :slight_smile:

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@Orion80, I think this is quite a clever concept to setup and try… Outside of the box thinking… Excellent!

Maybe get someone to code a Bot/Indicator that can track the movement and send notifications to you when your strategy is pushing the outer limits of elasticity, via percentage or distance from each other.

If you are confident of a retracement once your strategy has stretched. Maybe drop Stop and Limit (Pending) orders behind levels rather than open positions and guarantee drawdown. No doubt, Price will stagger looking for liquidity and possibly open these as well… But it’s just an idea.

You will struggle to put these instruments on the one chart, their prices vary too much.

@MattyMoney I believe is on the right track, Dennis’s SWA thread loosely uses this concept to formulate the strength and weakness of currencies by their distances above and below the MA200…

And I hope I have understood your theory correctly? A formula something like XAUUSD - XAGUSD / XAUUSD… say as percentage or maybe a distance (price)

var divergence = Math.Abs(XAUUSD[index] - XAGUSD[index]) / XAUUSD[index]; {0:P2}

You just have to flesh out the elasticity /arbitrage levels… And have them adjustable to cater for various instruments (pairs), volatility and time frames.

It will be pretty easy to code for MT4 (C++), maybe get some quotes… I code but not for MT4/5.

I wish you Good Luck with the strategy.

Edit: I crash coded this up to give you an idea of what it might display like…

cT_cs_3538837_US30_2022-07-16_03-49-12
cT_cs_3538837_US30_2022-07-16_03-49-122520×1001 129 KB

2 Likes
10

Sorry I left you hanging here, I’ll try to explain…

Similar to what I’m doing in my thread here and also more recently here. Trading the 2 currencies stretched furthest apart, looking for a retracement. But this is different from what you are doing because I’m not factoring in any correlation.

You can use this on any time-frame, but of course the question is when to buy and sell. If you looked at a few areas where prices separate you can probably come up with a min/max percentage/pip range that will trigger a buy/sell based on historical levels.

TradingView gives you the ability to overlay as many different instruments as you want. Here I’ve overlaid Gold and Silver/USD on the 5 min chart:

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…but it’s not right, the Gold line (dark blue) has been compressed due to the difference in the price scales (I’m assuming). I like what @Trendswithbenefits did with his, that’s perfect.

I don’t know if this was of much help, but it’s good to throw ideas out and see what sticks.

1 Like
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Thanks a lot for your reply! @MattyMoney

I think I understood the concept around the 200MA from the link to your second thread posted above.

You calculate the distance from the closing price from the 200EMA for all pairs with JPY.
Than you pick the one with the biggest change from previous day, and place your trade.

So I can do the same for example for XAUUSD and XAGUSD and check at the closing of the candle which one of the 2 is more far away from 200MA.

And then place the 2 trades according which one is more far away and one more closer to the 200MA.

I need to perform some calculation about this to check if it may work.

Yes the problem is to understand when exactly to place the buy/sell.

And you made me come up with an idea.

But first let me tell you that few days ago I also found the ability to overlay 2 pair in trading view. And also found a free indicator on internet for MT4 to overlay 2 chart.

As you said, your chart is not right. It’s because one instrument is scaled. Basically the price of the second instrument is in the form of the first. (Note: actually in trading view you can have price of one instrument as usual on the right, and price of the other instrument on the left).

This leads to distorsion. Distorsion can be in the form like your Gold chart, or can be a distorsion with the price of the second instrument sliding up and down while you scroll left and right the chart (it can be seen in trading view when you put 2 pairs on the same % scale).

For short term trades that last few candles, like those on the 15 minute tf, this distorsion is less impacting on the outcome of the trade I think.

But let’s go back to the idea you just made come up in my mind.

You wrote “If you looked at a few areas where prices separate you can probably come up with a min/max percentage/PIP RANGE that will trigger a buy/sell based on HISTORICAL levels.”

So that I commissioned on Upwork an EA which produce an excel files with the closing price of all candles (Both Main Pair and Overlayed Pair) and when I have this excel file I’ll do the difference of all the closing prices, which is the distance/pip range.

I also have already downloaded historical data for gold/silver from 1 January till 31 June.

And in file excel I’ll see which is the most convenient distance ON AVERAGE where to place buy and sell, in order not to have excessive drawdown.

I’m expecting this distance will vary month by month, semester by semester, (HISTORICAL LEVEL), and so it will be needed to be adjusted regularly on the run.

And if the analysis make sense for Gold/Silver I’ll repeat fot the other correlated pair. Only negative side is that I think it is time consuming.

Yes, it was of a lot of help! Or at least gave me an excellent option to be explored.
Thanks!

1 Like
12

Hello @Trendswithbenefits

Thank you for your post!!!

I’m trying to understand the formula that you wrote:

“XAUUSD - XAGUSD / XAUUSD”

What will give me?

A parameter that is higher when the distance increase and that is smaller when the distance decrease?

About elasticity / arbitrage levels I come up with an idea which I explained in my previous post in answer to @MattyMoney

It exactly involves to identify which is the ideal distance of pips (levels) where to place the buy/sell, not to end up with to much drawdown.

But to identify them it involves a lot of manual calculation in excel, for each couple of correlated pair.

Could be your formula (XAUUSD - XAGUSD / XAUUSD) a shortcut alternative to my Manual calculation? Maybe is that thet you mean?

13

Sorry Guys @MattyMoney @Trendswithbenefits

I just come up with another question.

Let’s say there is an Arbitrage Divergence on Gold / Silver and I want to Sell Gold and Buy Silver.

If I sell 1 Lot of Gold, how many lots of Silver should I buy?

Which is the formula to sell/buy the same amount on 2 different pairs?

1 Like
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Thanks mate!

1 Like
15

Interesting idea. I’ve done some analysis on the daily charts and there’s certainly possibilty here. What is very clear from the charts though is that market sentiment is the big driver in the difference. Risk off and gold is up to twice as much relative to silver as risk on markets.

What I am looking at is something interesting in using gold/silver divergence to give buy or sell signals for indexes. This looks very promising on larger time frames, but it’s a pig to code with one hand so going to take me a while. I’ll post the results here when I get somewhere

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Thank you! @chesterjohn

I appreciate your feedback.

I’ll wait for your results.

I believe in sharing is caring.

I have one question. You wrote:

I’m not native English speaker and I don’t understand the sense of this sentence. Can you explain it with other words, please?

Thanks

17

If you take XAUUSD/XAGUSD, the ratio is typically about 75. In risk off ie covid and now that is about 120, in risk on, it’s about 60. That’s a very big difference and seems more based on sentiment than an opportunity to trade divergence.

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I think I have just learned a new English expression :sweat_smile:
Risk off and Risk on. It’s the first time in my life I see them…

19

Keep plugging away, I’m sure you’ll eventually find a solution that doesn’t involve a ton of data entry. But it sounds like you’re off to a good start.

I don’t think you’ll necessarily need to buy and sell at the same time for the most part. Chances are you’re looking for a big(ish) move on one or the other. For example, suddenly silver dips but Gold doesn’t, no need to sell Gold, just buy the Silver dip.

As far as opening positions, I don’t base my trades on position sizes, I base them on my risk factor. I don’t want to risk $1,000 on one trade, so instead of buying by the lot I buy by the unit. BP has a risk calculator for that. TradingView also does the calculations for you, but your broker has to allow it as well. For example, MT4 platform only lets you buy micro-lots, but if you use MT4 through a broker such as OANDA (I’ll use them as an example because that’s who I use), you can trade as little as 1 unit.

Here, I only want to risk $100, but my trade is going to be obsolete if price hits 1780.000. So I fill in my parameters and it tells me how many units I can open:

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Here, I’m feeling confident and want to risk $1200, same SL:

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But I would never risk that much because it’s way higher than 1-2% of my account.

Know your risk before you place your trade or you won’t be trading for very long.

20

I think there is risk in trading only 1 pair.

Let’s take your example:

Silver dips and we buy Silver.

We expect that Silver goes up again.

But instead also Gold dips and the both keeping going down.

If we trade only Silver we will have a loss on Silver.

But if we trade both, when also Gold dips we are on Sell on Gold in profit. And in Buy in loss on Silver.

When they cross each other again we have a Net position of the 2 trades in profit.

So if you trade only one pair you don’t have the “Cover”.

I though to trade this strategy without stoploss. When we are in loss on one pair, we are in profit with the other. Having this kind of Cover we can trade without stoploss.

I know trading without SL is a bad habit, but given the typology of strategy with the Cover I was thinking to trade without SL.

What your thoughts on trading this strategy without stoploss? Do you think there are chances to blow the account?

Let’s say that I analyze data for 6 months for EURUSD and GBPUSD. I will know during this 6 months which have been the maximum drawdown for the strategy, when the elastic kept enlarging even more after trades were placed, and I’ll adapt the lots in order to have this max drawdown at 2%/3% loss of the account.

But in order to adapt the lot I need to know how many lot of silver compare with one lot of gold. Which is the formula?

You mention “BP” in your post. What does it stand for?