Improved Design Of Pairs Trading

Pairs Trading Strategy is originated from the legend Wall Street trader Jesse Livermore’ssister stocks trading strategies in1920s.It uses the invalidity of the market to make profits andit is one of the most popular and most important trading strategy used by hedge fundmanagers in U.S. and European stock markets. However, since the market is not standardizedand its system construction is imperfect, pairs trading is not suitable for China’s securitiesmarket in the early development of the market. Some institutional investors such as GuotaiJunan Securities and Haitong Securities began to introduce and study the strategy in2009with the development of China’s securities market.Although there are many domestic institutional investors studied pairs trading, traditionalpairs trading is still not suitable to China’s securities market due to some factors like shortselling restrictions and T+1system. Based on the analysis of existing research and combinedwith the status quo of China’s securities market, unilateral transaction is proposed for the pairtrading strategy. Through experiments we found that compared with the traditional pairstrading, unilateral transactions are no longer market neutral but have positive correlation withthe trend of the stock’s running. Therefore, we can enhance the probability of making profitsby choosing the upward trend stocks to operate the pairs trading. In order to filter out theupward trend stocks, the article selected the Momentum Strategy of two-year observationperiod and one-year trading period by Momentum Strategy. There are four specificoperational processes of the product. First, use the two-year observation period and one-yeartrading period to select the stock pool. Second, choose the stocks whose correlationcoefficient rank top by calculating the correlation coefficient of the stocks. Third, use theselected stocks to establish matching model and set trading rules. Fourth, conduct programtrading.In order to verify the feasibility and effectiveness of the product, this article uses themethod of historical simulation to do the experiment. The experimental result shows that from2004to2013, the ultimate yield of the improved pairs trading is36.19%while the yield of thesample is only22.78%and the Sharpe ratio of the improved pairs trading is6.809while theSharpe ratio of the sample is only4.8214. Therefore, the improved pairs trading have the feasibility and effectiveness.The improved pairs trading do not require the market offer short mechanism so that itcan be used in China’s securities market which improves the practical value of pairs tradingand this is the greatest value of the product.