Trading stocks using Principal Component Analysis

volatilityMan · January 8th, 2016, 1:04 pm

I was wondering if anyone had any experience with principal component analysis (PCA) with the purpose of buying stocks and thus trading? I have never dealt with PCA. Nevertheless, I would like to apply the theory in order to construct a portfolio consisting of some stocks and eventually consider the performance. The secondary goal would then be to compare to, say, a portfolio where the share of each stock is computed using GARCH.Best, VolatilityMan

mtsm · January 8th, 2016, 4:31 pm

It's way more difficult to do this for equities than it is for fixed income applications. But it is eminently doable, but way harder. Seriously, if you want to get something meaningful. You could consider buying a factor model also.

mtsm · January 8th, 2016, 4:31 pm

double - sorry

volatilityMan · January 8th, 2016, 5:24 pm

Thanks for your reply, mtsm. The complexity (difficulty) is not a problem. I am very interested in this procedure. a) Do you have experience with PCA in the below mentioned setting? Perhaps a good paper which I could use to initiate the journey? b) If you are interested (and have time), please feel free to elaborate a little on your suggestion regarding the factor model. Best, VolatilityMan

mtsm · January 8th, 2016, 6:16 pm

a) Yes, but it is not appropriate to discuss. Please refer to some books on factor models in general and equity factor models in particular.b) Just get in touch with the companies selling these.

ThomasJ · January 10th, 2016, 8:06 am

Classic paper here is Avellaneda & Lee (2008)

volatilityMan · January 10th, 2016, 4:25 pm

Thanks for your reference, ThomasJ. I have looked it through and it seems like a great starting point for my purpose.