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Pair Trading Strategy | PQM Method in the Framework of Pair Trading

Recently, the technology of pair trading has become greatly popular among traders. Pair trading, also known as statistical arbitrage or spread trading is a strategy which allows the trader to use anomalies, as well as fairly strong differences between prices of two stocks or baskets while maintaining neutrality of the market. The basis of the strategy is to identify correlated stocks and use moments when prices converge or diverge. Pair trading helps smooth price fluctuations and increases the predictability of the market. In other words, it creates a clearer, more predictable range for traders to trade. The task of the trader is to identify the timing of abnormal correlation.

It should be noted, however, that most of the existing trading terminals do not make it possible to carry out a serious technical analysis in the framework of the strategy of spread trading . Generally the trader has no opportunity to create a chart of a relative combination of assets he is interested in and to analyze it with various technical indicators. A lot of people use EXCEL for this reason, by exporting data and building charts out of the trading platform. The process is quite time-taking and not very convenient and effective.

Now, traders working with strategies of spread trading, are provided with an opportunity to create charts quickly and easily, and to carry out a complete technical analysis of simple and complex combinations of assets. Traders can do this thanks to the unique analytical functionality called PQM Method, which is implemented on the basis of trading-analytical terminal NetTradex. PQM is a completely new method of market analysis, allowing to compile portfolios of various assets and compare the value of portfolios with one another, creating a new financial composite instrument PCI (personal composite instrument).

It is possible to create both a quite simple PCI, and a very complex one. For example, a trader decided to analyze retrospectively the ratio of values of two American stocks from the same sector (Hewlett-Packard and IBM). It is a simple PCI (see chart).

PQM Method in the Framework of Pair Trading

Creating a chart will take no more than a minute. It is possible to choose any time frame (in the chart above weekly time frame is shown) and apply a wide range of technical indicators. Likewise, it is possible to build a chart of any complex PCI very quickly. A complex PCI can theoretically include any number of assets in each of the portfolios compared. Within the portfolio, the user can set a weight for each of the assets included in the overall portfolio. And importantly enough, the program automatically recalculates the values of all the assets in U.S. dollars (if they are traded in other currencies), allowing to compare the assets or portfolios properly with each other.
It should be also noted that the list of assets, which may be used to create various PCI , is quite large and includes almost all the segments of financial markets of various countries. Thus, traders who are engaged in pair trading have a very useful, convenient and effective tool in the form of PCI at their disposal.