Z-Score Bollinger Bands for Trading Mean-Reverting Spreads

Summary

This document describes a Bollinger-style trading rule for a constructed spread, commonly used in pairs strategies. It calculates a z-score by comparing the current spread with its rolling moving average and scaling by rolling standard deviation. A position is opened when the absolute z-score reaches an entry threshold; it is closed when the z-score moves back toward the entry level by a configured amount. The lookback windows and thresholds can be tuned on training data.

The rule is designed for incremental use: spread values arrive one at a time, entry signals are checked, and open trades are updated and closed as conditions change. The example demonstrates this process on a hedged two-asset spread, but presents no performance results. Threshold and window choices affect trade frequency and holding period, and optimization on training data does not establish out-of-sample profitability. The method also relies on the constructed spread behaving sufficiently mean-reverting for deviation-based entries to be useful.

Key ideas

• The spread z-score measures deviation from a rolling mean in units of rolling standard deviation.
• The strategy enters when the absolute z-score crosses a selected threshold.
• Exits are triggered as the z-score moves back toward the entry level by a configured amount.
• Moving-average and standard-deviation windows, as well as entry and exit thresholds, are tunable parameters.
• The example demonstrates sequential signal and trade updates but reports no strategy performance.

Tags

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