Friday, December 25, 2009

Overachievers vs underperformers

This paper got me thinking: market-neutral trading of two stock baskets seems like an elegant strategy. A 'long' basket should mainly consist of favorable stocks, performing above the index. It is then traded against a 'short' basket of underperformers. So each trade should deliver the alpha of the long and -alpha of the short basket. Seems like a great idea, but how to identify the right stocks? How consistent is the over- and underperformance?
 Here is my first shot at this.

In the graph above the average 10-day performance of a stock is plotted relative to the XLE index. Some patterns can be clearly seen, but to be honest, I'm not really thrilled.
Maybe I'll try using bollinger next time.

However, the cumulative returns seem much more interesting, through I don't have any particular use for it.

I think a better way to approach stock rating is to look at the stationarity of the tracking error.
But for now, I'll stick with building a cointegrating portfolio and trading it against a benchmark.

Files: stocks_XLE.mat, lag.m, analizeStock.m

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