Optimal Pairs Trading Rules. This thesis derives an optimal trading rule for a pair of historically correlated stocks. When one stock's price increases and the other one's decreases, a trade of the pair is triggered. The idea is to short the winner and to long the loser with the hope that the prices of the two assets will converge again. In this thesis the spread of the two stocks is governed by a mean-reverting model.
"Pairs trading using cointegration approach" by Heni Puspaningrum
A 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 strategy monitors performance of two historically correlated securities. When the correlation between the two securities temporarily weakens, i. Pairs trading strategy demands good position sizing, market timing , and decision making skill. Although the strategy does not have much downside risk , there is a scarcity of opportunities, and, for profiting, the trader must be one of the first to capitalize on the opportunity. While it is commonly agreed that individual stock prices are difficult to forecast, there is evidence suggesting that it may be possible to forecast the price—the spread series—of certain stock portfolios.
How To: Building a Trading Thesis
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A pairs trade is a trading strategy that involves matching a long position with a short position in two stocks with a high correlation. Pairs trading was first introduced in the mids by a group of technical analyst researchers that were employed by Morgan Stanley, the multinational investment bank and financial services company. The pairs trade strategy uses statistical and technical analysis to seek out potential market-neutral profits. Market-neutral strategies are a key aspect of a pairs trade transaction. Market-neutral strategies involve long and short positions in two different securities with a positive correlation.