Evaluating the Suitability of the Simplified Pairs Trading Strategy for Short-term Equity Market Trading

Julija Mosina; Grigorij Žilinskij

doi:10.18778/1508-2008.28.20

Authors

Julija Mosina Vilnius Gediminas Technical University, Faculty of Business Management, Department of Financial Engineering Vilnius, Lithuania https://orcid.org/0009-0007-3470-2907
Grigorij Žilinskij Vilnius Gediminas Technical University, Faculty of Business Management, Department of Financial Engineering, Vilnius, Lithuania https://orcid.org/0000-0002-8484-8695

DOI:

https://doi.org/10.18778/1508-2008.28.20

Keywords:

pairs trading, market-neutral strategy, investment strategy, short-term equity trading

Abstract

Pairs trading has been a successful tool for traders since its inception in the 1980s and has evolved significantly with the introduction of algorithmic, machine, and AI trading. This evolution has complicated the implementation of this strategy that traditionally benefits institutional or specialized investors. Despite this, the simplicity of pairs trading remains accessible, indicating potential benefits for ordinary traders. By focusing on the strategy’s fundamental principles and employing a real-time market test on a popular trading platform, the study aims to reveal its applicability and efficacy for short-term equity trading. Utilizing basic trading platform tools and Excel functions, the research aims to demonstrate a simplified approach to pairs trading. The findings will provide insights into the strategy’s effectiveness, providing non-expert traders with a viable approach to navigate today’s volatile markets through a simplified yet effective pairs trading model. The experiment’s findings highlight varying performances across different stock pairs, with notable differences in volatility. While five out of 11 pairs achieved positive returns, only two met the closure criteria within the short-term horizon, suggesting that a longer trading period and a more diversified pair’s portfolio may be necessary to fully capture expected price convergence.

Downloads

Download data is not yet available.

References

Bowen, D.A., Hutchinson, M.C. (2016), Pairs trading in the UK equity market: risk and return, “The European Journal of Finance”, 22 (16), pp. 1363–1387, https://doi.org/10.1080/1351847X.2014.953698 DOI: https://doi.org/10.1080/1351847X.2014.953698

Broussard, J.P., Vaihekoski, M. (2012), Profitability of pairs trading strategy in and illiquid market with multiple share classes, “Journal of International Financial Markets, Institutions and Money”, 22 (5), pp. 1188–1201, https://doi.org/10.1016/j.intfin.2012.06.002 DOI: https://doi.org/10.1016/j.intfin.2012.06.002

Brunetti, M., Luca, R. (2023), Pre-selection in cointegration-based pairs trading, “Statistical Methods & Applications”, 32, pp. 1611–1640, https://doi.org/10.1007/s10260-023-00702-4 DOI: https://doi.org/10.1007/s10260-023-00702-4

Buda, A. (2011), Life Time of Correlation between Stocks Prices on Established and Emerging Markets, https://doi.org/10.48550/arXiv.1105.6272

Caneo, F., Kristjanpoller, W. (2020), Improving statistical arbitrage investment strategy: Evidence from Latin American stock markets, “International Journal of Finance & Economics”, 26 (3), pp. 4424–4440, https://doi.org/10.1002/ijfe.2023 DOI: https://doi.org/10.1002/ijfe.2023

Diao, H., Liu, G., Zhu, Z. (2020), Research on a stock-matching trading strategy based on bi-objective optimization, “Frontiers of Business Research in China”, 14, 8, https://doi.org/10.1186/s11782-020-00076-4 DOI: https://doi.org/10.1186/s11782-020-00076-4

Engelberg, J., Gao, P., Jagannathan, R. (2008), An Anatomy of Pairs Trading: The Role of Idiosyncratic News, Common Information and Liquidity, “SSRN Electronic Journal”, https://doi.org/10.2139/ssrn.1330689 DOI: https://doi.org/10.2139/ssrn.1330689

Fernández-Pérez, A., Frijns, B., Indriawan, I., Tse, Y. (2020), Pairs trading of Chinese and international commodities, “Applied Economics”, 52 (48), pp. 5203–5217, https://doi.org/10.1080/00036846.2020.1761009 DOI: https://doi.org/10.1080/00036846.2020.1761009

Figà-Talamanca, G., Focardi, S., Patacca, M. (2021), Common dynamic factors for cryptocurrencies and multiple pair-trading statistical arbitrages, “Decisions in Economics and Finance”, 44, pp. 863–882, https://doi.org/10.1007/s10203-021-00318-x DOI: https://doi.org/10.1007/s10203-021-00318-x

Gatev, E., Goetzmann, W.N., Rouwenhorst, K.G. (2006), Pairs Trading: Performance of a Relative-Value Arbitrage Rule, “The Review of Financial Studies”, 19 (3), pp. 797–827, https://doi.org/10.1093/rfs/hhj020 DOI: https://doi.org/10.1093/rfs/hhj020

He, J., Liu, J., Fu, Y., Zhu, Y., Zhou, Z., Tong, Y. (2023), Applications of Copulas and Machine Learning Algorithms on Pairs Trading, “BCP Business & Management”, 46, pp. 1–11, https://doi.org/10.54691/bcpbm.v46i.5070 DOI: https://doi.org/10.54691/bcpbm.v46i.5070

Huck, N., Afawubo, K. (2015), Pairs trading and selection methods: is cointegration superior?, “Applied Economics”, 47 (6), pp. 599–613, https://doi.org/10.1080/00036846.2014.975417 DOI: https://doi.org/10.1080/00036846.2014.975417

Huřťák, P. (2024), Why Is Sweetgreen (SG) Stock Rocketing Higher Today, https://finance.yahoo.com/news/why-sweetgreen-sg-stock-rocketing-164037775.html (accessed: 15.01.2004).

Jacobs, H., Weber, M. (2015), On the Determinants of Pairs Trading Profitability, “Journal of Financial Markets”, 23, pp. 75–97, https://doi.org/10.1016/j.finmar.2014.12.001 DOI: https://doi.org/10.1016/j.finmar.2014.12.001

Keshavarz Haddad, G., Talebi, H. (2023), The profitability of pair trading strategy in stock markets: Evidence from Toronto stock exchange, “International Journal of Finance and Economics”, 28 (1), pp. 193–207, https://doi.org/10.1002/ijfe.2415 DOI: https://doi.org/10.1002/ijfe.2415

Krauss, Ch. (2015), Statistical Arbitrage Pairs Trading Strategies: Review and Outlook, “Journal of Economic Surveys”, 31 (2), pp. 513–545, https://doi.org/10.1111/joes.12153 DOI: https://doi.org/10.1111/joes.12153

Lee, D., Leung, T. (2020), On the Efficacy of Optimized Exit Rule for Mean Reversion Trading, “International Journal of Financial Engineering”, 07 (03), 2050024, https://doi.org/10.1142/S2424786320500243 DOI: https://doi.org/10.1142/S2424786320500243

Lee, K., Leung, T., Ning, B. (2023), A Diversification Framework for Multiple Pairs Trading Strategies, “Risks”, 11 (5), 93, https://doi.org/10.3390/risks11050093 DOI: https://doi.org/10.3390/risks11050093

Liew, R., Wu, Y. (2013), Pairs Trading: a Copula Approach, “Journal of Derivatives & Hedge Funds”, 19, pp. 12–30, https://doi.org/10.1057/jdhf.2013.1 DOI: https://doi.org/10.1057/jdhf.2013.1

Mashele, H.P., Terblanche, S.E., Venter, J.H. (2013), Pairs trading on the Johannesburg Stock Exchange, “Investment Analysts Journal”, 42 (78), pp. 13–26, https://doi.org/10.1080/10293523.2013.11082559 DOI: https://doi.org/10.1080/10293523.2013.11082559

Miao, J., Laws, J. (2016), Profitability of a Simple Pairs Trading Strategy: Recent Evidences from a Global Context, “International Journal of Theoretical and Applied Finance”, 19 (4), 1650023, https://doi.org/10.1142/S0219024916500230 DOI: https://doi.org/10.1142/S0219024916500230

Mohandas, G. (2023), Cointegration-Based Pairs Trading Strategy in Commodity Markets: A Novel Approach to Statistical Arbitrage, “International Journal of Science and Research (IJSR)”, 12, https://doi.org/10.21275/SR231123060916 DOI: https://doi.org/10.21275/SR231123060916

Moulya, H., Mohammadi, A., Thathaiah, M. (2019), Evaluation of Pairs Trading Strategy: A Study of Global Currencies, “Pacific Business Review International”, 11 (10), pp. 67–85.

Platania, F., Appio, F., Hernandez, C., Ouadghiri, I., Peillex, J. (2023), A multi-objective pair trading strategy: integrating neural networks and cyclical insights for optimal trading performance, “Annals of Operations Research”, 346, pp. 1553–1572, https://doi.org/10.1007/s10479-023-05754-z DOI: https://doi.org/10.1007/s10479-023-05754-z

Sahu, A., Singh, A.P., Pradhan, A., Kumar Shukla, G., Rizvi, S., Bugata, U.K., Sen, J. (2023), A Cointegration and Clustering Based Approach to Pair Trading of Stocks from Selected Sectors of the Indian Stock Market, https://doi.org/10.36227/techrxiv.23539989.v1 DOI: https://doi.org/10.36227/techrxiv.23539989.v1

Schizas, P., Thomakos, D., Wang, T. (2011), Pairs Trading on International ETFs, “SSRN Electronic Journal”, https://doi.org/10.2139/ssrn.1958546 DOI: https://doi.org/10.2139/ssrn.1958546

Soputro, S., Imron, A., Saiban, K. (2023), Consumer Protection in Commodity Futures Trading Transactions in the Physical Crypto Asset Market, “International Journal of Social Science Research and Review”, 6 (12), pp. 54–62, https://doi.org/10.47814/ijssrr.v6i12.1707 DOI: https://doi.org/10.47814/ijssrr.v6i12.1707

Tadi, M., Witzany, J. (2023), Copula-Based Trading of Cointegrated Cryptocurrency Pairs, “FFA Working Paper 4/2023”, Prague University of Economics and Business, Prague.

Tenyakov, A. (2017), A computing platform for pairs-trading online implementation via a blended Kalman-HMM Filtering approach, “Journal of Big Data”, 4 (1), 46, https://doi.org/10.1186/s40537-017-0106-3 DOI: https://doi.org/10.1186/s40537-017-0106-3

Vakrina, E. (2007), Matematinės statistikos pradmenys. Statistinių duomenų analizė naudojant MS Excel, http://olgal.home.mruni.eu/wp-content/uploads/2008/04/mat_stat_excel.doc (accessed: 15.01.2024).

Wang, Y., Li, X., Wu, P., Xie, H. (2023), Many-to-Many Pair Trading, [in:] B. Li, L. Yue, C. Tao, X. Han, D. Calvanese, T. Amagasa (eds.), Web and Big Data. 6th International Joint Conference, APWeb-WAIM 2022, Nanjing, China, November 25–27, 2022, Proceedings, Part I, Springer Nature Switzerland, Cham, pp. 399–407 https://doi.org/10.1007/978-3-031-25158-0_31 DOI: https://doi.org/10.1007/978-3-031-25158-0_31

Wu, L., Zang, X., Zhao, H. (2020), Analytic value function for a pairs trading strategy with a Lévy-driven Ornstein-Uhlenbeck process, “Quantitative Finance”, 20 (8), pp. 1285–1306, https://doi.org/10.1080/14697688.2020.1736613 DOI: https://doi.org/10.1080/14697688.2020.1736613

Yahoo Finance (2024), https://finance.yahoo.com/ (accessed: 20.02.2024).

Yu, C., Xie, T. (2021), Multivariate Pair Trading by Volatility & Model Adaption Trade-off, “Journal of Financial Economics”, https://doi.org/10.48550/arXiv.2106.09132

Zivot, E. (2015), Introduction to Computational Finance & Financial Econometrics Return Calculations, University of Washington, Washington.