Strategies · Core
Pairs Trading with Stocks
Trade a spread between two historically linked stocks when it is statistically wide, and unwind when it mean-reverts.
Definition
Form pairs on correlation, cointegration, or industry match. Enter when the residual z-score exceeds a threshold; exit at a mean or a stop. Dollar- or beta-neutral. Daily or faster. Costs and borrow decide whether the paper edge lives.
Why it matters
It is the textbook market-neutral recipe. Crowding, corporate actions, and a broken hedge ratio are how it dies.
Case
A pair that was cointegrated until a merger rumor. The z-score ‘signal’ was a regime change. The stop is the strategy.
How to read it
Formation vs trading window, neutrality, and cost per round-turn versus expected half-life. A 2-sigma rule without a stop is a hope.
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