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Pairs Trading: A Bayesian Example

Stefan Hollos and J. Richard Hollos

List price: $19.95 print, $9.99 ebook
Format: print/Kindle/pdf, 71 pages
ISBN: 9781887187152 (paperback), 9781887187114 (ebook)
Publication date: Aug 2012

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Table of Contents

Have you ever wondered whether Bayesian analysis can be applied toward the stock market? We did, and set out to investigate.

This 71 page book shows you how to find relationships between stocks or exchange traded funds (ETFs) using Bayesian analysis.

A relationship that most traders are probably familiar with is linear correlation. This is sometimes used as the basis for pairs trading. But linear correlation is just one way that stocks or ETFs can be related.

The analysis we present in this book can be used to exploit almost any kind of relationship that may exist between stocks or ETFs. The book will show how to calculate the probability of a stock or ETF ending the day up or down based on what other stocks or ETFs are doing.

A probability is more useful than a simple up or down signal. It quantifies the certainty of a prediction and allows a trader to take a position consistent with a given level of risk.

Any active trader should find the techniques presented in this book useful. We are only going to examine the relationships in one small group of ETFs as an example of what is possible but the same techniques will work for any set of stocks, ETFs, or even bonds.

The tool we use to calculate the probability of a positive or negative return on a stock or ETF is called a Bayesian classifier. It is called a classifier because it calculates probabilities for only two discrete outcomes: positive or negative.

The method we use to calculate these probabilities is called Bayes' Theorem.

In this book we not only show you the results of our analysis, but we show you HOW to do the analysis,... AND we give you the Bayesian classification software (available here) that we have developed FREE of charge. The software alone is worth several times that of this book.

You can get this book now at Amazon as a paperback or Kindle ebook.

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You can also get this book instantly as a pdf from Gumroad.

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By the way, our software is general enough to be able to classify things other than just stocks and ETFs. All you need is to collect data that you think might be relevant to classify your object of interest. The software will allow you to determine whether you have data with the power to classify. The book will show you how to do all this.

About the authors: Stefan Hollos and J. Richard Hollos are physicists by training, and enjoy finding patterns and information in data. They are the authors of Probability Problems and Solutions, Combinatorics Problems and Solutions, The Coin Toss: Probabilities and Patterns, Bet Smart: The Kelly System for Gambling and Investing, as well as Simple Trading Strategies That Work, and are brothers and business partners at Exstrom Laboratories LLC in Longmont, Colorado. The website for their quantitative finance related work is QuantWolf.com.

Table of Contents

Send comments to: Richard Hollos (richard[AT]exstrom DOT com)
Copyright 2012-2013 by Exstrom Laboratories LLC