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

Get Weekly Commentary on Small Markets!

Sign up to start receiving free analysis on everything from stocks and bonds to commodities and foreign exchange.

Tags:

Latest Articles

The End of an Era for the Euro
Frank Kaberna07/05/2022

The End of an Era for the Euro

If you started trading in the last two decades, you’ve only known a world in which the euro is worth more than the US dollar. You’d have to go all the way back...

Read More →
3 Ways to Buy Bitcoin with Higher than 50% Probability
Video
The Small Exchange07/01/2022

3 Ways to Buy Bitcoin with Higher than 50% Probability

Buying a market like Bitcoin at this deep of a discount can be nice, but doing so with an added edge in your favor thanks to options can be even better. Mikey...

Read More →
Will Euro Reach Parity with US Dollar?
Video
The Small Exchange06/30/2022

Will Euro Reach Parity with US Dollar?

Currencies are known to be less volatile assets than stocks or commodities, but the euro currently rests in a quite precarious position relative to the US...

Read More →

Prices

Loading...