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RV (Macro) And Convergence Trades

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Long Dax, Short NKY, Long EURJPY.  Stops beyond recent lows/high on 1 hour charts (see picture).  Betting on (temporary) reversal of recent divergence (Dax near lower end of range, NKY near upper end;  this divergence between major exporters performance in spite of weakened EURJPY does not seem sustainable.  Bet is simultaneously also on global markets breakout out of recent ranges in either direction.  JPY weakened previous weak (reversing) - may indicate that reallocation of Japanese investors' from global to domestic stocks (if any..), which could have contributed to relative NKY strength, may have peaked before (of course unless they were mostly FX-hedged).  Japan's Covid advantage may have played a major role as well in establishing the divergence, so have most likely BoJ ETF purchases.  The former should by now be "priced in" - unless Europe Covid situations worsens drastically (relative Dax overnight outperformance may confirm this).  Would expect BoJ to at least not cause itself a significant breakout of NKY to the upside, and instead keep some powder at these levels.  Timing probably not ideal after strong DAX overnight move, guess (some) retracement before/at cash open likely, however also risky to have a one-directional trade open until then, hence rather Dax stop relatively wide.  Rising EURJPY would be strong factor justifying further NKY outperformance - hence long to reduce risk.  Ideally trade should run for a bit, however review after US open (if not stopped out..). 

C_1.thumb.png.144cca443b6762972200a7d4e4b71738.png

 

 

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stop on short NKY was hit quickly.  closed EURJPY and Dax soon after for a small aggregate profit.  didn't expect Dax to extend gains that much today.  was unfortunately far too early, as it turned out.  guess with one leg closed so quickly I thought better safe than sorry, or just got nervous.  another one to learn from..

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I would not go long the Dax and short the Nikkei because the two are so highly correlated that it is likely to lead to mixed results.

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1 hour ago, AndrewS said:

because the two are so highly correlated

That was part of the idea of this "convergence trade".  Both tanked on Monday 21, but then Nikkei 225 more than fully recovered, while Dax did not (see picture above).  Not being aware of a reason that seemed (IMHO) strong enough to justify the extent of the difference in behavior of these recently more similarly moving indices, I positioned for the relative differences of Dax and Nikkei levels to their respective Monday opening levels to converge (in other words, I bet on their rate of returns since that day to approach a more similar value).  One could also say at that stage I considered the relative value of the Dax with respect to the Nikkei 225 as higher than the prices indicated.

The high correlation between the two instruments, if it persists, should cause such a trade to have lower risk than a directional position in either of these indices, because you are hedged against factors that impact both markets similarly.

Of course this doesn't come for free, but as you seem to have in mind, you're also not profiting when both markets move in the same direction - have I understood you correctly?

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54 minutes ago, HMB said:

 

The high correlation between the two instruments, if it persists, should cause such a trade to have lower risk than a directional position in either of these indices, because you are hedged against factors that impact both markets similarly.

 

In practice I think such a trade has a higher risk because your exposure is twice as much by going long one index and short the other at the same time. Also there is additional risk because managing the two trades together is much more difficult than managing one trade. Since the two indices are so highly correlated I think it is lower risk to go long the Dax when the Nikkei is coming off support or to sell the Nikkei when the Dax is coming off resistance. The temporary out performance of one index relative to the other is much less of a story in comparison to the strong correlation.

This is the current correlations of the Dax to other indices for the past twenty periods..

GER30H1.jpg.b136103ae57c28066ce930f00baa731a.jpg

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34 minutes ago, AndrewS said:

In practice I think such a trade has a higher risk because your exposure is twice as much by going long one index and short the other at the same time. Also there is additional risk because managing the two trades together is much more difficult than managing one trade. Since the two indices are so highly correlated I think it is lower risk to go long the Dax when the Nikkei is coming off support or to sell the Nikkei when the Dax is coming off resistance. The temporary out performance of one index relative to the other is much less of a story in comparison to the strong correlation.

This is the current correlations of the Dax to other indices for the past twenty periods..

GER30H1.jpg.b136103ae57c28066ce930f00baa731a.jpg

Think I know what you mean - of course, if you compare a combination of  two trades with a notional exposure of e.g. 10000 each with one trade with a notional exposure of 10000, you may lose more with the combination than with the single trade.  I should have stressed this more clearly - thanks for highlighting this.

 

Edited by HMB

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On 29/09/2020 at 05:57, AndrewS said:

go long the Dax when the Nikkei is coming off support or to sell the Nikkei when the Dax is coming off resistance

took me a while, but think I understand that, too, now...  yes, I agree, in cases where only one index trades near clear support/resistance, the high correlations may justify taking such turns also as signal for the other index, depending on circumstances.  good point, will keep that in mind 

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