AT THE CLOSE
Pair Trading With Spreadsheets by Ron McEwan
Build a spreadsheet to aid in revealing profitable opportunities in pair trades.
Pair trading is classified as a market neutral
strategy where you are not concerned with
market direction, whether up or down. Instead,
the idea is to exploit temporary price discrepancies
in two (or more) securities by simultaneously
going long the outperforming security and going
short the underperforming one.
An important concept in pair trading is in
selecting securities that have a spread with a
“mean reverting” (comovement) characteristic.
Correlation of the two securities was
often used as a measure to find similarity
in the movement of two or more securities.
Correlation is not always indicative of mean
reversion. Cointegration is a more accepted
method for detecting mean reversion — that
is, comovement — of the spread in securities.
Other than knowing that cointegration is a way to measure comovement
or mean reversion, it is not necessary to go into detail about it
here. There are commercial software packages and web services that
will perform cointegration analysis on a pair of stocks. In addition,
there are free scripts for Matlab and “R,” the free language and environment
for statistical computing and graphics, that will perform the
For this article I have constructed an Excel spreadsheet to aid in
identifying the spread in a pair of stocks that have a mean reversion
characteristic that can be traded profitably.