Pairs
Trade the spread between two related series · 9 min
- Market A (rebased)
- Market B (rebased)
Each wanders on its own, but the gap between them keeps closing.
Two markets usually move together. Today B jumps 5% while A is flat. What does a pairs trader do, if the pair reverts?
A pair is two markets tied by something real: two companies in the same business, a stock and its index, two deliveries of the same commodity. Each can trend, but the spread between them may revert. A pairs trade holds one long and one short, so the market's overall moves mostly cancel.
The hedge ratio must be estimated on data before the trading period; fitting it on the whole history leaks the future into the test. The big risk is a broken link: a merger, a new product, a change in the business. Then the spread trends, and a reversion rule keeps adding to a loser. Switch the relationship below to see it.
- A (rebased to 1)
- B (rebased to 1)
- Spread z-score (30 days)
- Entry levels
- Pair trade, after costs
The hedge ratio is fitted on the first 250 days only; trading starts after them.
Generated markets, not real data. They show how a rule depends on the market it meets; they do not predict how real markets behave.
Spread and z of a pair (in price terms)
- B, A, hedge ratio
- 82.40, 50.00, 1.6
- Hedge leg
- 1.6 × 50.00 = 80.00
- Spread = B − 1.6 × A
- 82.40 − 80.00 = 2.40
- Spread mean, standard deviation
- 0.50, 0.95
- z of the spread
- (2.40 − 0.50) ÷ 0.95 = +2.0: sell B, buy 1.6 A per B
A pair has reverted for years. One of the companies is bought by a rival. What should a pairs trader expect?
B = 64.00, A = 30.00, hedge ratio 2. What is the spread B − 2A?
The spread is 4.00, its mean 1.00 and its standard deviation 1.20. What is its z-score, and the trade?
Missed questions come back for review after one day, then three, then a week.
Pair: B trades at 83.26, A at 50, hedge ratio 1.5 (short 1.5 A per B held). What is the spread B − 1.5 × A?
Hint: Spread = price of B − hedge ratio × price of A.
Three years of a fresh generated world are on screen; the next two years do not exist yet. Tune the rule on what you can see, commit to two predictions, then generate the future.
- Your rule so far
Over the next two years, after costs, this rule will…
Will the pair still revert after the split?
Generated markets, not real data. They show how a rule depends on the market it meets; they do not predict how real markets behave.