The implied market timing ability behind the index pairs trading

In the "The theory of pairs trading" post, we point out that "In a bull market, growth stocks tend to outpace value stocks, and in a bear market, value stocks perform better". In other words, when the pairs trading model suggests to long NQ and short YM, the market is likely to go up, otherwise, the market is likely to drop. This is the implied market timing ability of the index pairs trading model.

This timing ability can be demonstrated in above transactions. During all 5 completed "long NDX short DOW" trades, market indices were all up, while in 3 of  5 completed "short NDX long DOW", the market was down. Therefore, the timing probability is 80%! The current signal is "long NDX short DOW". Even though the US market dropped on April 30, the market recovered the loss on May 1st, suggesting that market indices are likely to go up when we close the current transaction. By the way, the current trade reverses to make about $60 from yesterday's -$331.82 loss.

This timing ability can enable us to improve the performance significantly. We can buy call or put options on indices or ETFs based on signals to add addition returns to the pairs trading.