Leader & Laggers S&P 500 Update

In my last post I talked about a program that would find a stock that would lead or lag a stock you selected.  Lets take $AAPL for example.  Below are the top 5 positive and negatively related intra-day stocks for Apple Computers calculated on 9/18/2010 with 5 minute bars.

AAPL Leaders and  Laggers

However, there is a special attribute to this information.   $AAPL time1 is not correlated with $DTV time1 then squared (that is how you calculate R^2. Read about it here).  It is correlated with time3 of $DTV.  The illistration below should help.  (Please note the prices below are for examples purposes only)

Lead Laggers Example

On the left is the traditional stock by stock correlation.  On the right is a leaders/laggers correlation.  What this does is allow you to have an understanding of what $DTV will do with greater confidence than if it was correlated with $AAPL time1.  The reason is this:  When a stock is trending that trend can change suddenly and if you’re pairs trading or using correlated stocks it will change immediately with it.  When you lead/lag the R^2 tells you that while $APPL is rising 10 mins later $DTV should be rising as well (within a degree of confidence of course). Also if $APPL is reaching a bottom $DTV should reach a bottom 10 minutes later.  The chart below should illustrate this concept

AAPL DTV Chart Lag Lead

As you can see as $AAPL hits a bottom at $243.62 at 11:45am $DTV hits it’s bottom at 37.70 11 minutes later at 11:56.  This is the power of lead/lag.  There are many strategies one can implement knowing this information.

I am working on posting popular lead/lag coefficient such as the ES_F, EURUSD, and $AAPL within this up coming month.

Hope you enjoyed this post