By IFCMarkets

Good afternoon, dear investors. Today we traditionally consider examples of the PCI technology application for generating synthetic instruments: paired spreads, portfolios and composite instruments, such as portfolio spreads. We return to the simplest case: pairs trading of the two related assets. Let us recall that the contraposition of two assets is determined by the ratio of their prices according to the given volumes. Considering a high relatedness of assets the investor has the opportunity to monitor a personal composite instrument PCI instead of two elementary instruments. One of the traditional methods of determining the degree of colligation is the linear correlation coefficient, or “correlation”, which indicates the linear dependence of the value of assets. This r coefficient lies in the range [-1,1]. Considering negative correlation values, the underlying asset value growth leads to a drop in value of the quoted asset and vice versa: the flat becomes unstable. Thus, the correlation difference of values -100%,, i.e. r +1 indicates the potential for the trend movement of “a composite”. We believe that the use of the arbitrage spread is advisable under such a condition.

Here we consider two commodity futures #C-FCATTLE and #C-SOYB. The use of soybean as a meat substitute suggests the inverse demand relationship for these two products. The hypothesis is tested using the IND_Correlation indicator, one of the many indicators that allows us to construct the correlation coefficient. The indicator is publicly available at the MQL5 forum: http://ift.tt/1lo2jsh. We attached it to the daily #C-FCATTLE chart and determined the horizon of 13 days to calculate the correlation between the value of frozen beef and soybean futures. We can see that the signal line approached the marginal value of -1 and corresponds to the last level at -0.92. This confirms the inverse dependence of the assets at the level of 13 days and the intensive trend movement can be expected.

Let us consider the daily chart of the #C-FCATTLE/#C-SOYB composite instrument, formed in the NetTradeX trading platform. The correlation coefficient deviation to the negative half-plane corresponds to the vicinity of May 1-5: during this period a new uptrend begins on the PCI daily chart. The correlation can be used as an additional oscillator confirmation. At the moment, we see that the RSI oscillator came into the overbought zone and approaches the marginal value of 100%. At the same time the price approaches the historical resistance of 1.01582, which is likely to become the initial level of a strong correction start, taking the oscillator behavior into account. We believe that this key level may act as a risk-limiting, and the position can be opened below 0.92777, the intersection of which will cause a reversal of the Parabolic SAR trend indicator, the moving average breakthrough and the price return within the Bollinger channel. Partially the profit target can be fixed at 0.80623 in the vicinity of the support line.

It is significant to note that we choose 13 days as a statistical volume of all the indicators: the same period that was used for correlation analysis. The consistency principle of the analysis methods is respected. Opening a position, it is recommended to move the Stop Loss after the parabolic values every day after the order execution. Thus, we can optimize the return/risk ratio in our favor in the process of changing market conditions.

Market Analysis provided by IFCMarkets