Pair Trading

Pair trading – interesting and efficient trading system, based on looking for correlative financial instruments with similar market dynamics, and on usage of imbalances between them for profit. The main idea of pair trading consists in that similar financial instruments in the same way react to market events: news output conditions change, etc. In most cases the way it is: if you take, for example, two competing companies that produce interchangeable products, they will respond to the same news, and their shares tend to grow or fall simultaneously. Therefore, if we take the difference between these two tools, which is called the spread, the market component of it will be excluded, and the spread will tend to some average value around which it will perform random oscillatory motions. So, the essence of the strategy of pair trading just consists in trapping of these oscillations. When spread goes away above their average value, is carried out the sale of overpriced tool and purchase of underrated, when spread goes away below, on the contrary – the purchase of the first and sale of the second. For more information about pair trading can be found here.

Pair Trading

The development of a trading system for trading the pair always starts with finding appropriate pair for this way of trading. This is the most crucial and difficult step in using this strategy, on which the majority of traders stumble. The fact that the number of trading instruments on different markets measured in hundreds and it is almost impossible to sort out all pair combinations manually. Especially that for each combination it will be necessary to find the optimal weights and estimate the stationary spread. Of course, you can try to select a pair, focusing on the fundamentals, for example, belong to the same sector of the economy. But, firstly, for this it is necessary to have special knowledge, and secondly, you still have to manually produce a set of calculations, and, thirdly, will lose a lot of interesting combinations that can not be found only in the fundamental information.

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And here to the aid can come a variety of online services, automatically calculates the correlation between the instruments and pick up a pair. For example, on megatrader.org site is a free service for the automatic selection of the pairs for the pair trading. There you can find free services for the calculation of the correlation between trading tools and online tools for mapping spread charts between any instruments.

The next step in the development of systems for the pair trade is to create a trading algorithm. Fortunately, there is no problems arise because the very essence of the pair trading leads naturally to the idea of an algorithm: it is enough to construct a moving average of the spread and open trade when it deviates from a predetermined value, and to close when the spread is back to her. Instead of moving average and fixed levels of deviation, Bollinger lines are often used. Of course optimal levels of deviation and the parameters of the moving average will need to pick up, focusing on the results of historical test. Of course, you can use other, more advanced trading algorithms. But the pair trading is so good because for properly selected pairs and with simplest algorithm it will always make a profit.

Pair trading – interesting and efficient trading system, based on looking for correlative financial instruments with similar market dynamics, and on usage of imbalances between them for profit. The main idea of pair trading consists in that similar financial instruments in the same way react to market events: news output conditions change, etc. In most cases the way it is: if you take, for example, two competing companies that produce interchangeable products, they will respond to the same news, and their shares tend to grow or fall simultaneously. Therefore, if we take the difference between these two tools, which is called the spread, the market component of it will be excluded, and the spread will tend to some average value around which it will perform random oscillatory motions. So, the essence of the strategy of pair trading just consists in trapping of these oscillations. When spread goes away above their average value, is carried out the sale of overpriced tool and purchase of underrated, when spread goes away below, on the contrary – the purchase of the first and sale of the second. For more information about pair trading can be found here.

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The development of a trading system for trading the pair always starts with finding appropriate pair for this way of trading. This is the most crucial and difficult step in using this strategy, on which the majority of traders stumble. The fact that the number of trading instruments on different markets measured in hundreds and it is almost impossible to sort out all pair combinations manually. Especially that for each combination it will be necessary to find the optimal weights and estimate the stationary spread. Of course, you can try to select a pair, focusing on the fundamentals, for example, belong to the same sector of the economy. But, firstly, for this it is necessary to have special knowledge, and secondly, you still have to manually produce a set of calculations, and, thirdly, will lose a lot of interesting combinations that can not be found only in the fundamental information.

And here to the aid can come a variety of online services, automatically calculates the correlation between the instruments and pick up a pair. For example, on megatrader.org site is a free service for the automatic selection of the pairs for the pair trading. There you can find free services for the calculation of the correlation between trading tools and online tools for mapping spread charts between any instruments.

The next step in the development of systems for the pair trade is to create a trading algorithm. Fortunately, there is no problems arise because the very essence of the pair trading leads naturally to the idea of an algorithm: it is enough to construct a moving average of the spread and open trade when it deviates from a predetermined value, and to close when the spread is back to her. Instead of moving average and fixed levels of deviation, Bollinger lines are often used. Of course optimal levels of deviation and the parameters of the moving average will need to pick up, focusing on the results of historical test. Of course, you can use other, more advanced trading algorithms. But the pair trading is so good because for properly selected pairs and with simplest algorithm it will always make a profit.

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Post Author: Pooja S

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