Pairs Trading with Price-Spread Bollinger Bands

Summary

The document explains statistical pairs trading as a market-neutral mean-reversion approach. It describes selecting two securities with historically similar price behavior, then selling the relatively expensive leg and buying the relatively cheap leg when their spread diverges. The positions are closed in the opposite direction if the divergence narrows, with the intended profit coming from convergence rather than the market's overall direction.

Its outlined procedure skips a pair when either security is halted, calculates the recent price difference, and uses the spread's mean and variance to construct Bollinger Bands. A move above the upper band prompts a short-spread position, while a move below the lower band prompts a long-spread position; each is described as using half the available allocation. The document provides no empirical results or precise rules for estimating and maintaining the relationship. Convergence is an assumption, and correlation alone does not establish that a spread will revert.

Key ideas

• Pairs trading buys the relatively weaker security and sells the relatively stronger one when their spread diverges.
• The strategy seeks profit from spread convergence and is presented as market neutral.
• Recent price differences and Bollinger Bands are used to identify potential spread entries.
• The method assumes the pair relationship persists and the divergence will correct; no performance evidence is supplied.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.