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22 pair trading strategyAmong the variety of trading strategies that traders use in their work in financial markets, a particular place is occupied by market-neutral strategies - the strategies of pair trading.

WHAT IS PAIR TRADING?

This is a kind of trading method, consisting in the simultaneous, in most cases, multidirectional, opening of transactions by trading assets. In this case, trading assets should be interdependent. Properly selected assets have a similar reaction to market movements. For example, shares of energy / commodity companies react equally to changes in oil prices. Therefore, the multidirectional opening of positions with such instruments allows you to hedge / insure against predictable energy flows to some extent. By the way, for this reason, this type of strategy is called market neutral, because they are not much dependent on market movements.

To better understand the principles of interaction of trading assets in pair trading, you can consider an example. There are many similar products on the market that have similar characteristics, have similar parameters, but differ in price. The buyer will naturally choose the product that will be cheaper, since he does not consider it necessary to overpay for analogs with the same quality characteristics.

Gradually, cheap goods will gain popularity, and its price will begin to grow along with the increase in demand for it. That is, market mechanisms begin to influence its price, and after a while we will see that both goods, both expensive and cheap, equalize in price and will have approximately the same value. In this case, the goods do not necessarily have very similar characteristics. The difference in the characteristics of goods, and as a consequence, the difference in their price, is taken into account in paired trade in the form of weight coefficients in the spread. We, as it were, use the weighting factors of the spread to bring goods to the form, in which we can compare them.

FACTORS, WHICH AFFECT THE CHANGE IN MARKET RATES

The rates of various trading assets are constantly changing. These changes occur in a fairly large range, and to see this, it is enough to look at the statistics of historical values ​​over the past few years. Many factors influence the change in the rates of trading assets. Here are the most significant of them:

  • news background of the world market (macroeconomic indicators);
  • economic events;
  • social and political news;
  • force majeure circumstances and extreme events, floods, terrorist acts, earthquakes, fires and similar events that affect the exchange rate fluctuations, various trading assets and instruments.

Note that it is practically impossible to predict the above events, and given that they cause significant movements of world markets, these events are one of the factors of "market uncertainty" / chance.

Most financial market assets / instruments have internal relationships. The reason lies in the increasing globalization of the economies of the world, the interpenetration of world capital in the economies of all countries. If in any country there was an event that affected the change in the exchange rate of the national currency (whether in a positive or negative aspect), then due to these interrelations, this event will necessarily affect the general news world background and the exchange rate of other countries.

All events taking place in the world change the general equilibrium of global assets for a while, but in the future it is restored at about the same level. It is this feature that is used in paired trade. Those. The portfolio of assets is traded at the moments of "unbalancing" towards its historical significance.

WHAT IS THE SPREAD ON THE FINANCIAL MARKET AND HOW IS IT CALCULATED?

Spread - this is the price difference, between the quotes of trading assets. In this type of trading, a spread means the difference between the quotes of two instruments in a pair, with each instrument participating along with its weighting factor.

The general formula for calculating the spread is: Spread = a * PriceA - b * PriceB.

Where, a and b are weights that are used to balance asset positions.

PriceA and PriceB are the prices of trading assets.

In general, the amount of deviation of the spread from its average value shows the magnitude of the "imbalance" of trading assets.

SPREAD AS A TRADING ASSET

It should be noted that the spread, like any trading asset, can be traded. The way of trading a spread is similar to trading, any other instruments, with the difference that in this case the position (spread) means the aggregate of two differently directed positions. Spreads (a set of positions) are also called synthetic trading assets.

The purchase of a spread is understood as the simultaneous purchase of one, and the sale of another instrument. Under the sale - on the contrary, the simultaneous sale of one and the purchase of another instrument. Volumes / values ​​of the lots of assets that must be taken for transactions should be proportional to the weight of the spread.

To build a trading system for spread trading (pair trading), you need to have historical spreads. The deeper the history is available, the more reliable a trading system can be built. One of the trading ideas is that schedules of well-constructed spreads often return to some medium value. To implement the trading algorithm, the average lines, imposed on the spread schedule, are often used. If the spread from the middle line deviates by a predetermined amount, the transaction opens to the middle line. It closes when the spread and the middle line converge. It remains for the trader to choose the values ​​of the deviations and the period of the middle line. Of course, to build a trading algorithm, you need to have specialized software that can work with spreads. Unfortunately, such software is not cheap, but costs, as a rule, pay off handsomely with the correct approach to trading.

MATCHING PAIRS FOR SPREAD TRADING

One of the main tasks in the pair trading is the proper selection of trading assets to build a spread. It is necessary to find those assets whose spread will constantly return to the average value and all traffic of the graphs will be concentrated within the limits of some channel. Trading such a pair is quite simple and enjoyable, and the attendant risks are minimal.

There are several ways to find trading assets for a spread.

  1. Independently, using the correlation tables of trading instruments.
  2. Use paid / free services that publish finished spreads.
  3. Specialized programs for constructing / analyzing spreads.

It is not easy to choose pairs manually, especially for beginners, because of the large number of different assets, which number is not one thousand. The trader needs to analyze the market, determine the reaction of assets to the news background, and then manually select the weights of the assets and evaluate the resulting schedules and the quality of the spread.

Easier, more efficient and faster can be matched with specialized and automated programs. They can be found on various web services that allow you to make the right selection of pairs using filters in online mode. For example, there are services in which it is enough to conduct a trading asset of interest to a trader and the program independently, taking into account the historical data, he will select a pair. As a result, the trader receives a ready spread along with the charts and weights of the incoming instruments.

There are also more complex programs that allow you to select not only pairs of assets, but also spreads from several tools. Usually such services are used by more experienced traders who have trading skills and experience.

CONCLUSION

The use of multidirectional trading positions (spread trading) allows to significantly reduce the influence of little predictable market factors and use short-term imbalances in trade assets in trade. In this, in its reliability, regardless of the current market conjecture and scientific validity, paired trading / spread trading has a significant advantage over other trading methods.

The spread of computers, as well as the availability of historical data in trade quotes, make this type of trade accessible to a large number of traders.