Design statistical arbitrage strategies using correlated assets.
Pairs trading seeks to profit from temporary deviations in the price relationship between two correlated instruments. When the spread diverges from its historical mean, a trader can go long the undervalued asset and short the overvalued one.
Constructing reliable pairs requires robust statistical testing. Look for co-integration and stable long term relationships before committing capital. Backtesting on Matador helps validate that the spread mean reverts consistently over different market regimes.
Risk management is crucial for pairs trades. Set stop levels on the spread and monitor correlation breakdowns. Because two positions are involved, transaction costs can quickly erode profits if the spread oscillates rapidly without converging.