Pair trading is a promising trading system that has gained great popularity among professional traders. One of the reasons for the growing popularity of paired trading is the stability of trading results. Stability is due to the fact that this type of trade uses the internal, deep interdependence of trading instruments, which changes little over time. It is the slow variation of dependencies over time that allows trading systems based on pair trading to remain profitable for a long time. Stability of results – this is the main difference between paired trading strategies and strategies that use at their core individual trading instruments.
As trading tools for pair trading, as a rule, they use tools that respond to external factors in the same way. For example, a reduction in the commodity reserves of oil leads to an increase in its value, and, as a consequence, an increase in the shares of oil companies. The charts of trading instruments, which are connected by fundamental dependencies, are very similar to each other. In this case, they say that they are correlated. It is precisely from the correlated, and with a high degree of correlation, the spread of the trading instruments.
For pair trading, in addition to shares, it is also possible to use currency pairs, since many of them are also related to fundamental factors. At the same time, one should keep in mind that for pair trading only those currency pairs that have a correlation coefficient of more than 80% are suitable. To select such pairs, you can use the service to calculate the correlations
. Please note that the information on this service is updated daily and, using it, you will always have up-to-date data.
Selecting the appropriate pairs, you need to build a spread from them, i.e. Pick up such weighting coefficients so that the resulting spread graph is predictable and similar, for example, to a sinusoid or straight line. In other words, the spread graph must have regular patterns that are easy to continue. Manual selection of weights – the task is almost not feasible, and here you can use the service of pair matching. This service will automatically calculate the coefficients for each instrument and plot the resulting spread.
How can the trading algorithm look like? The simplest and at the same time reliable method is trading from the middle line. Once the spread deviates from the average value by a given amount, you need to open the transaction towards the middle line and close when the spread returns to the average value. Selecting the parameters of the midline and the magnitude of the deviation should be achieved, using historical testing, a steady increase in the balance of the deposit. Creating a spread, historical testing of results and the trade itself can be done using the MegaTrader PairTrading program. For more information about a pair, trading can be found on the megatrader.org website.