Thread: Neutral Market Corner

"Neutral market" is a confusing and simplistic term. Neutral to what exactly? To currency exposure? To the total risk of the stock market? To delta? To what type of base risk? After applying make-up -forgive, stationary processes- to financial series, they seem neutral to the naked eye. Example: DOW and DAX, Neutral in Dollar "without makeup" DOW and DAX, "with delineator, base, lipstick, etc." "Neutral to what exactly" is the question of the billion, and I still don't have the answer. Without maximums, without minimums. It must be Bose!

Neutral to management... Look at the DAX-FTSE, correlation of 93.5%. If you had sold FTSE and purchased DAX at certain levels and out in others, you would be in gain. That’s spread trading, nothing new. You just need a time frame and a loss/gain limit (like closing with 6% loss or 6% gain or after a week

Neutral to "direction", yes. But you have to define well what is "direction"; it is not the same as neutral in dollars or beta, which indicate exposure to risk. Neutral to direction is very subjective. For a pure spread, like the one you propose, it can work with some technical rules. But to be market neutral, that two assets go in the same direction does not guarantee that they move equal in distance. Thank you. No maximums, no minimums. It must be Bose!

Neutrality can mean many things. To define direction I use a mobile media. Simple and direct. Here the important thing is risk management, not making the perfect tortilla without breaking eggs. I have read about neutral beta strategies, but like any complex strategy, it has the problem of maintenance. When something like this fails, there is not much to do. That’s why I prefer the simple thing. In a spread, I only care about the correlation and volatility of the pairs. If I think the FTSE is going to fall and I’m wrong, I make up for a length in DAX. So, even if I fail in the direction, the loss is less than if I only operate the FTSE.

Again: a high correlation coefficient is not enough. It is not even necessary! Upstairs there are two series with 100% correlation. They are never found again. Below there are two co-integrated series. Their correlation is -0.02%. No greed. No fear. Only mathematics.

Your analogy of ice cream made me the day. I never saw better explained what a spread and a neutral approach is. If all books came like this, another story would be.

The irony is that most people are looking for "low risk" strategies without really understanding what kind of risk they are trying to neutralize. More theory, less myths.

Have you considered using PCA (major component analysis)

A lot of calculation and a lot of theory for something that you can't retest with real market conditions, the neutral market works well until it stops doing it.

There is nothing neutral in a market that moves by tweets and rumors of war. Sometimes neutrality is a statistical fantasy.