Pairs Trade

By
rjonesx
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Definition

The pairs trade or pair trading is a market neutral trading strategy enabling traders to profit from virtually any market conditions: uptrend, downtrend, or sideways movement. This strategy is categorized as a statistical arbitrage and convergence trading strategy. The pair trading was pioneered by Gerry Bamberger and later led by Nunzio Tartaglia’s quantitative group at Morgan Stanley in the 1980s.

Pairs Trade

What is ‘Pairs Trade’

The strategy of matching a long position with a short position in two stocks of the same sector. This creates a hedge against the sector and the overall market that the two stocks are in. The hedge created is essentially a bet that you are placing on the two stocks; the stock you are long in versus the stock you are short in.

Explaining ‘Pairs Trade’

It’s the ultimate strategy for stock pickers, because stock picking is all that counts. What the actual market does won’t matter (much). If the market or the sector moves in one direction or the other, the gain on the long stock is offset by a loss on the short.

Pairs Trade FAQ

How do you calculate terms of trade?

Terms of trade (TOT) is the ratio between a country’s export and import prices. The ratio is calculated by dividing the price of the exports by the price of the imports and multiplying the result by 100.

What is meant by terms of trade?

Terms of trade is the ratio between the index of export prices and import prices. If the export prices increase more than the import prices, a country has a positive terms of trade, as for the same amount of exports, it can purchase more imports.

Is pairs trading still profitable?

Pairs trading can achieve profits through simple and relatively low-risk positions. The pairs trade is market-neutral, meaning the direction of the overall market does not affect its win or loss. If the pair reverts to its mean trend, a profit is made on one or both of the positions.

How do you choose pairs for pairs trading?

Choose a pair of stocks that move together very closely, based on a certain criteria (i.e. Coke & Pepsi) Wait until the prices diverge beyond a certain threshold, then short the “winner” and buy the “loser” Reverse your positions when the two prices converge –> Profit from the reversal in trend.

How do you find a pair of trades?

Step one: Identify the Trend. The first thing to do when choosing which pair to trade is to identify the trend. Step two: Pairing your Trend with the Trading Strategy. The next step is to ensure those pairs fit the strategy you intend to trade. Step Three: Noting the ATR.

What is pair trading strategy?

A pairs trade is a trading strategy that involves matching a long position with a short position in two stocks that are closely related.

Further Reading

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