Strategy
1 Pair Trading Strategy Overview
Trading Setup
- Data Frequency: Daily resolution
- Hedge Ratio Update: Every two weeks
- Cointegration Test Frequency: Every two weeks
- Trading Session Timeout: 10 days
2 Strategy Logic
Calculate Hedge Ratio Compute the hedge ratio \(\beta_i\) based on the past 20 days of log prices: \[ \beta_i = \frac{\text{Cov}(\log P_{\text{RIVN}}, \log P_{\text{TSLA}})}{\text{Var}(\log P_{\text{TSLA}})} \]
Compute Spread \[ \text{Spread}_t = \log(P_{\text{RIVN}, t}) - \beta_i \cdot \log(P_{\text{TSLA}, t}) \]
Cointegration Test Test 60-day rolling window of log prices for cointegration using the ADF test.
Z-Score Based Trading Rules If cointegration is statistically significant:
- Entry: if \(Z > 2\) or \(Z < -2\)
- Exit: if \(|Z| < 0.5\)
- Stop Loss: if \(|Z| > 3\)
Trading Session Timeout Force close any open positions after 10 trading days.