Exploiting the tendency of a correlated pair's price spread to revert to its mean. The market-neutral concept, the five-step procedure, and the 'reverse-martingale' trap that destroyed LTCM.
Pair trading (statistical arbitrage) is a method institutions and hedge funds have used for a long time. Only about 4 of the 98 catalogued methods fall here — a minority, but with a logic alien to every other category.
The idea: the price spread between two highly correlated instruments (or currencies) tends, over time, to revert to its mean. So when the spread widens beyond normal, you put on a hedge — "sell the side that rose, buy the side that fell" — and close both when the spread reverts to the mean. Only the change in the spread is the source of return.
For example, AUD/JPY and NZD/JPY are both resource-currency pairs with similar economic structures. So they usually move alike, and the spread stays in a band. But when some catalyst moves only one of them sharply, the spread widens. Given time, correlation reasserts and the spread reverts — that is the root principle.
How to Read
OANDA:USDJPY
How to Read
OANDA:USDJPY
The Esoteric Volumes · By Application
Capital, discipline, psychology. The chapters that sit behind technique describe the bone-work that keeps an operator in the market for years. Access requires a written application, reviewed by hand.