9 Oct, 2024|RESEARCH

Pair Trading

Pair trading is a market-neutral strategy exploiting price movements between two correlated assets. Its popularity has surged due to crypto market volatility. Traders seek pairs with historical correlation, monitoring price spreads to identify long and short opportunities.

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Executive Summary

Pair trading is a market-neutral strategy that involves taking advantage of relative price movements between two correlated assets. By simultaneously buying one asset and selling another, traders seek to profit from the convergence or divergence of their prices.
In this report, we demonstrate how to use a pair trading strategy to perform trading with a daily interval, with the BTC-ETH pair as the example. The trading strategy is evaluated based on the data from January 2021 to August 2024.
- The price ratio (BTC/ETH) is the tracking indicator, as it presents a mean reversion in the period.
- Buy and sell signals need to be determined for when to enter and exit trading. Z-Scores with a moving window of 30 days are calculated, and then the upper and lower thresholds of Z-Scores for trading signals are set.
According to historical data, the strategy could generate significant positive gains when trading signals are well defined and may perform better than simply holding assets within specific time ranges.
Pair trading strategy purely relies on historical price relationships without considering fundamental factors. Additionally, there are some limitations regarding this exploration, including the stationary assumption, lack of out-of-sample testing, market conditions, transaction costs, and risk management.