Pairs trading/Cointegration confusion

External question — Quantitative Finance Stack Exchange Author: 43zombiegit Original post: https://quant.stackexchange.com/questions/63848 License: CC BY-SA 4.0 — https://creativecommons.org/licenses/by-sa/4.0/ Adaptation: HTML converted to plain text; contact email addresses removed. I've been trying to wrap my head around cointegration. Currently I use the log returns of both stocks A and B, calculate the spread given by: $S = log(A) - n*log(B)$ where $n$ is the Hedge Ratio calculated from a rolling OLS. In the results I've read I've operated under the assumption that if the spread falls below a certain point then long A and short B and vice versa. I believe this is a dollar neutral hedge? My confusion lies in the Hedge ratio part whereby I'm not sure how to interpret it. I've seen an example that says long A and short $n$ stocks of B. However, I sometimes get negative values of $n$ , i.e log returns are inversely correlated. How do I interpret this?

External answer — Quantitative Finance Stack Exchange Author: Dhruv Mahajan Original post: https://quant.stackexchange.com/a/63933 License: CC BY-SA 4.0 — https://creativecommons.org/licenses/by-sa/4.0/ Adaptation: HTML converted to plain text; contact email addresses removed. Did you check for cointegration b/w A and B before running the regression? You should not get a negative hedge ratio for 2 assets that are deemed to be co-integrated with a sufficient confidence level. If they are infact cointegrated, try increasing the look back period for calculation of rolling hedge ratio from OLS, might be the case that beta is negative for a certain small time period.