WHAT'S PAIR TRADING? ADVANTAGE AND ITS DISADVANTAGES

Pair trading is a strategy used in financial markets, including the Cryptocurrency market, where an investor simultaneously buys and sell two related assets to profit from the relative price movements between them. The idea is to take advantage of the correlation between the two assets

-when one goes up, the other tends to go down by going long on one and short on the other.

This strategy aims to minimize market risk while potentially capturing profits from relative value changes.

ADVANTAGES OF PAIR TRADING

a. Risk reduction - pair trading involves taking long and short positions on two correlated assets.,aiming to profit from the relative performance between the two. This strategy can help reduce overall market risk as its not solely dependent on the broader market direction.

b. Market neutral strategy - pair trading is a market - neutral strategy, meaning it's designed to generate returns regardless of whether the broader market is trending up or down.

c. Diversification - By simultaneously holding both long and short positions in related assets, pair trading allow diversification within a specific sector or industry.

d. Potential for consistent returns-pair trading look to capitalize on temporary divergences in price between two related securities with an expectation that they will revert back to their historical relationship overtime.

e. Flexibility-The strategy can be applied across various assets classes such as stocks, options, futures or forex pairs offering.

DISADVANTAGES OF PAIR TRADING

a. Market risk-pair trading does not eliminate market risks entirely. If the entire market experiences a downturn, both legs of the trade may suffer losses.

b. Transaction cost- Frequent trades associated with pair trading can lead to higher transaction costs with eating into potential profits.

c. Exécution risk- There's always a chance that one leg of the pair trade might execute poorly or at an unfavorable price, leading to unexpected losses.

d. Regulatory changes or interventions could impact correlated assets differently, affecting the success of trades unpredictably.

e. Complexity and monitoring- Managing multiple positions simultaneously requires close attention and can be complex for less experienced traders.

f. Margin requirements - Trading on margins can amplify gains but also magnify losses if not managed properly.

g. Corrélation breakdown- The assets being traded may experience a breakdown in their historical correlation, rendering the pair trade in effective or even counter-productive.