Pairs Trading: How to Get Started

Jun 22, 2022

By The Small Exchange

Overview

Pairs trading is an active strategy that attempts to profit from the contracting or expanding relationship between two similar assets. The first step in finding a pairs trading opportunity is simply making sure the two markets you're comparing are indeed similar. You can do this by calculating correlations between historical prices or simply looking at charts and intuiting the answer. For example, airline stocks like UAL and AAL are likely to have a very high correlation given that they operate in the same sector; same goes for historical price action in stocks and interest rates - when one moves higher, the other tends to follow.

The second step in pairs trading is finding the opportunity between these similar markets and acting on it. Frank explores the expanding divergence between stocks and interest rates over the last year, and he attempts to profit from their potential return to normal in the future by buying a beat-up stock market using Small Technology (STIX) futures and selling interest rates at their highs using Small 10YR Treasury Yield (S10Y) futures.

Contents

0:05 Pairs Trading: How to Get Started

1:20 Criteria for a Pairs Trade

3:00 Stocks vs Interest Rates Example

3:40 Stocks vs Interest Rates Correlation

4:26 Finding a Pairs Trade

5:20 Setting up the Trade

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