I'm not going to make this technical. I don't have time to examine my four of five months of Stat Arb trading.
Message on Medisoft's Wall
"Medisoft.... I can assist you with the forward testing of buy/sell g/u and e/u to e/g. Well... not forward test but at least back test lol. Please run a google search for basket profit 2 pairs. This indicator was designed to show the basket profit for two pairs. If you define the periods to around 5000 you get a great view of price movement over time. If you zoom all the way out and have another chart with e/g open (line chart) you will see they are almost identical. I will post the rest on the thread."
By showing the profit of a basket pair (Buying one Selling the other) and surrounding price with 2 or 3 standard dev's, and placing a mean in the middle of the st dev, one is actually able to see when one currency pair is out performing the other. Lets say you put in A/U long and N/U short in the indi. If the basket is above the mean near the 2nd st dev A/U is over performing. So you would trade short A/U and long N/U. The reverse is true if the indi showed price at the -2 st dev. That would mean that N/U is over performing and A/U is under performing. Thus you would short N/U and long A/U back to the mean.
All in all by showing the profit you are essentially, in a round about way, showing the price difference.
As I have said before, I have traded this for a while, actually since the origin of this thread. I scoured the internet to find more information about Stat Arb. Another forex website which will remain nameless has several threads on the subject. While combing this websites for other methods of Stat Arb I came across an indicator called Basket profit 2 pairs. This indicator shows a line graph of a basket (in this case 2 pairs) over time. It also places standard dev around the line to show the standard dev of price over a defined period of time based on the number of periods you enter. I used 5000 periods on the 5min chart. This, by the way, can be quite taxing for a computer so you may need to give MT4 several minutes to load. You will also have to have ample history for the indicator to process for each pair.
I traded N/U A/U REALLY REALLY GREAT SUCCESS for a while. These pairs were great. As I have stated before, the countries economies are intermingled.
However, A/N started trending very strong during the Summer. At the same time I noticed that the basket indicator was showing that price was moving farther and farther outside the standard dev lines. I was trading when N/U&A/U would move +-2 standard devs from the mean, back the direction of the mean. AUD/USD was trending hard while NZD/USD was falling, doing nothing, or raising slowly. My account balance began to dwindle. The price difference was growing farther and farther apart.
In searching for an answer to what was happening to keep price so far away from 2 st dev (There is also an indi that shows 3 st dev that I also used) I realized that a A/N line graph looked almost exactly like my indi line graph.
Again I must reiterate my previous post, A/U and N/U worked so well for a while because A/N is a ranging pair.
When A/N was not trending you could count on pretty consistent profits. Now I pay attention to A/N.
Mr. zjmoser is correct. I must also say again that it is not the spread you gain by A/N or , the pair that most of you seem to like more, E/G it is the lessened margin requirement that you gain that is most beneficial.
If anyone needs a better explanation they are welcome to email me some time.