📈 Pairs Trading Strategy – Statistical Arbitrage

Quantitative Researcher | Mustafa MAJJI

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This project explores the implementation of a pairs trading strategy, a form of statistical arbitrage that aims to profit from relative mispricings between two historically correlated assets. While not truly zero-risk, the strategy is considered market-neutral and seeks to minimize directional exposure by taking offsetting positions in paired assets.

🔍 Strategy Overview

The core idea behind pairs trading is that if two assets are cointegrated—i.e., they have a stable long-term relationship—then temporary divergences in their prices can be exploited. When such a divergence occurs, the strategy assumes that prices will revert to their historical equilibrium. Therefore:

• 🔻 You short the asset that has become overvalued.
• 🔺 You go long on the asset that has become undervalued.

🧪 Project Workflow

Step1: Data Acquisition

• Import the list of all companies listed on the NASDAQ.

Step2: Market Cap Classification

• Group companies into:
  • Large-cap: Market cap > $10 billion.
  • Mid-cap: $2 billion < Market cap ≤ $10 billion.

Step3: Liquidity Filter

• Select the top 100 companies by average trading volume to ensure sufficient liquidity.

Step4: Price Normalization

• Normalize historical price series for comparability across assets.

Step5: Distance Calculation

• Compute Euclidean distances between normalized price series to find closely moving pairs within the same group (Large-cap or Mid-cap).

Step6: Pair Selection

• Select pairs with the smallest distances, indicating strong co-movement.

Step7: Sector Consistency Filter

• Retain only pairs from the same sector to increase the likelihood that both are influenced by similar macroeconomic or industry-specific factors.

Step8: Cointegration Testing

• Apply the Johansen cointegration test to validate long-term statistical relationships. Discard non-cointegrated pairs.

Step9: Trading Signal Generation

• Define entry and exit thresholds on the spread between the paired assets.

• Go long/short depending on whether the spread exceeds a set upper or lower limit.

📪 Contact

For any information, feedback or questions, please contact me