Pairs trading strategy in stock trading
Pairs trading is a fairly simple strategy that involves making a profit through the correlation of several assets.
That is, in stock trading the principle is used - if the price of one asset rises, then another asset that has a direct correlation will certainly rise in price.
The concept of pairs trading itself originated in the 1980s thanks to mathematicians and quant analysts at the investment bank Morgan Stanley.
Since then, the strategy has undergone significant changes and development, becoming accessible and attractive to a wide range of investors.
Today, pairs trading is one of the most popular strategies in the stock markets, due to its unique ability to minimize risks and stabilize profitability in any market conditions.
Typically these are shares of companies in the same industry or other assets whose prices move in unison. Traders use special programs and algorithms to track correlations and identify suitable asset pairs.
Pairs trading has a number of advantages, the main ones being stability and the ability to make a profit even in a falling market. However, like any other strategy, it has its drawbacks.
The main one is the difficulty in selecting assets and the need for constant market monitoring. Additionally, this strategy may require significant investment to achieve meaningful returns.
Therefore, let’s try to figure out what assets the pairs trading strategy can be used on.
Pair trading on company shares
The simplest example of making money on stocks using pair trading is given on Wikipedia . The essence of this option is the relationship between the price of goods and the prices of shares of companies associated with the production of these goods.
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For example, it is natural that when the price of oil rises, the prices of shares of oil producing companies begin to rise in price.
When pairs trading in stocks, assets from the same industry are often selected. Let's say we find that Apple and Microsoft stocks are highly directly correlated. As soon as the value of the securities of one company begins to rise, shares of another are purchased.
Pairs trading Bitcoin and gold
Surprisingly, these two assets also have a direct and stable correlation, so when gold rises, you can open a long position in Bitcoin.
The relationship between the price of gold and the price of Bitcoin is described in detail in the article - https://time-forex.com/interes/korrelacya-zoloto-bitcoin
As you can see, these two assets move almost in parallel and are excellent for pairs trading; this fact has been confirmed more than once. At the moment, gold has risen in price to $1,990 per 1 ounce and Bitcoin has risen in price above 29,000 per coin.
Pairs trading on currency pairs
For this strategy, you need to select currency pairs that have a direct correlation and then proceed to the direct application of the strategy itself.
In this case, the most effective solution is to use a correlation indicator , which will show current information on the relationship of currency pairs.
It is important to take into account that the successful application of a pairs trading strategy requires certain skills and knowledge from the trader. Here are some tips and tricks for traders using this strategy:
- First of all, it is necessary to carefully analyze the two selected assets to ensure their relationship.
- You need to constantly monitor the price dynamics of the selected assets in order to respond to changes in a timely manner.
- Don’t forget about risk management: when opening a trade, you need to determine the stop loss and take profit levels in advance.
- You should not rely solely on pairs trading - it should only be part of an overall trading strategy.
Of course, the correlation is not always perfect. Sometimes assets that are highly correlated can move in opposite directions. This is called negative correlation. In this case, we may lose money if we do not take this possibility into account.