Constructing a Custom Composite Benchmark for Pair Trading

Summary

This short forum exchange addresses how to use a custom benchmark for a strategy such as pair trading, where a portfolio of two stocks may be a more relevant comparison than a broad market index. The suggested approach is to construct an index from the two stocks' prices within the strategy when the benchmark is needed for calculations.

The discussion distinguishes that internal use from displaying a custom benchmark curve in the platform's performance chart, which the response says was not supported at the time. A participant notes that another platform allowed weighted component securities to define a benchmark, and the possibility of adding similar support is raised. The exchange gives no formula for index construction, weighting guidance, or performance evidence, so implementation details and the platform limitation may not generalize beyond the stated context.

Key ideas

• A pair-trading strategy can use a benchmark built from the prices of its component stocks.
• The forum response recommends constructing the desired index within the strategy when it is needed for calculations.
• The discussed platform could not display that custom index in its performance chart at the time.
• The exchange mentions weighted component securities as an approach available on another platform, without detailing its implementation.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.