Definition
Cointegration means two price series that individually wander randomly (non-stationary) maintain a stable spread over time. This is stronger than correlation—two series can be highly correlated without being cointegrated, and vice versa. The Engle-Granger or Johansen test identifies cointegrated pairs. Cointegration is the statistical foundation for pairs trading and spread strategies.
lightbulb Example
Gold futures and gold mining stock prices are cointegrated: both can trend up or down independently, but the ratio between them reverts to a stable mean. When the ratio deviates 2+ standard deviations, a pairs trade captures the reversion.
verified_user Key Points
- Stronger relationship than correlation
- Two non-stationary series with stationary spread
- Foundation for pairs trading strategies
- Engle-Granger and Johansen tests identify cointegrated pairs