We like to see high correlation and high cointegration.
Remember, correlation measures how much the two securities move in the same direction at the same time. Since we are trading a reversion of their price ratio to the mean at a moment when they are "out-of-whack", we actually need the spread between them to converge, not just move in the same direction. So while correlation tells us a lot about how similar two securities return profiles have been, it doesn't necessarily mean the spread will converge.
We like to see correlation >60%. However, if Cointegration is very strong, we believe a lower correlation can be tolerated for the reasons above.
We call a pair cointegrated when Cointegration (as measured by PTF) is showing 0.90 or higher. That equates to a p-value of 0.10 or less in the ADF test. Some traders would only call 0.95 or higher Cointegrated. Up to you.
At the end of the day, what Geoff - our Managing Director - think makes the strongest case for trading a pair is that:
1. It is FUNDAMENTALLY correlated - that means the two stocks are in a very similar line of business and logically should react to economic developments in a very similar fashion. Use the Fundamentals Snapshot in PTF PRO to easily review the necessary parameters and make your judgment;
2. It has a long backtest history of at least 8 or 9 trades that are showing a great return profile.
But that's us! You may take a different view.