Symbols Correlation, built for pair trading

30 Jun

Overview:
This script is designed for pairs trading. If you are not familiar with pairs trading, I suggest learning about it, as it can be a profitable strategy in neutral markets (or neutral trends between two assets). The correlation between two assets is the foundation of pairs trading, and without it, the chances of making a profit are low.
Correlation can be described in two opposite ways:

• 1: Absolute positive correlation (meaning the asset prices move together).
  
• -1: Absolute negative correlation (meaning the asset prices move in opposite directions).
  

Any value between 1 and -1 indicates some degree of correlation, but generally, values higher than 0.7 or lower than -0.7 are considered significant.

Features:
Typically, correlation is measured using the closing prices. This script adds three more correlation studies based on open, high, and low prices. By using all four lines, we can get a better understanding of the pair's correlation.

How to Read This Indicator:
To use this indicator effectively, you need to input your pair as a ratio. For example, if your pair is TSN and ZBH, enter it in the symbol search as: TSN/ZBH

• Gray Area: This area indicates "no high correlation" (default is between -0.8 and 0.8, adjustable in the settings).
  
• Gray Line: This represents the close correlation within the "no high correlation" range.
  
• Green Line: This represents the close correlation within the "high correlation" range.
  
• Dot Lines: These represent the open, high, and low correlations.
  

Example Interpretations:

• A: All four lines are close together & the line is green – very good correlation!
  
• B: The line is gray, and the dot lines are apart – not a strong correlation.
  
• C: When the close correlation remains green for a long time, it signals a strong correlation.
  

Application in Pairs Trading:
In pairs trading, aim for the highest possible correlation, and it is important to have a sustained correlation over a long period. Pairs that correlate only part of the year but not consistently are less reliable for pairs trading.

This is an example for good correlation for pairs trading:


This is an example for bad correlation for pairs trading:


Here is a view of my full indicators when doing pairs trading: