Cointegrationbased

Cointegrationbased refers to trading or investment strategies that utilize the statistical property of cointegration. Cointegration occurs when two or more time series, which may individually be non-stationary, exhibit a long-run equilibrium relationship. This means that while the individual series might wander randomly, a linear combination of them remains stationary.

In a cointegrationbased strategy, a trader or analyst identifies a pair or group of assets that are cointegrated. For example, stocks of two companies in the same industry might exhibit cointegration if their prices are influenced by similar underlying economic factors. When the prices of these cointegrated assets diverge significantly from their historical long-run relationship, a trading opportunity may arise.

The core idea is to bet on the reversion to this equilibrium. If the spread between the cointegrated assets widens beyond a certain threshold, a strategy might involve shorting the outperforming asset and going long on the underperforming asset. The expectation is that the spread will eventually narrow, allowing the trader to profit from the convergence. This is often referred to as pairs trading or statistical arbitrage.

To implement cointegrationbased strategies, statistical tests such as the Engle-Granger or Johansen tests are used to confirm the presence of cointegration. The effectiveness of these strategies relies on the assumption that the identified long-run relationship will persist and that deviations from this relationship are temporary. However, structural breaks or fundamental changes in the underlying factors can disrupt cointegration, leading to potential losses.