Disadvantages of Pairs Trading
AAA
  1. Pairs Trading: Introduction
  2. Pairs Trading: Market Neutral Investing
  3. Pairs Trading: Correlation
  4. Arbitrage and Pairs Trading
  5. Fundamental and Technical Analysis for Pairs Trading
  6. Pairs Trade Example
  7. Pairs Trading: Risks
  8. Disadvantages of Pairs Trading
  9. Advantages of Pairs Trading
  10. Pairs Trading: Conclusion

Disadvantages of Pairs Trading

Aside from the risks associated with pairs trading, there are a number of disadvantages to this investment technique of which traders should be aware. Perhaps the most obvious disadvantage is that each trade necessitates twice the commissions and fees. If an investor were to simply go long, he or she would pay one commission to enter and one to exit the trade. A pairs trader, however, must pay two commissions to enter and two commissions to exit each trade. Depending on the particular strategy employed, this can add up quickly. Commissions should be factored into any historical modeling to determine if the strategy can, in fact, make a profit.
 
The outcomes of execution risk are also a disadvantage in pairs trading. Slippage, partial fills and bid-ask spreads can reduce profits. The bid-ask spread is the amount by which the ask price exceeds the bid, or the difference in price between the price a buyer is willing to pay for a security (bid), and the and the price a seller wants for that security (ask). The trading volume of the securities greatly affects the bid-ask spread; instruments that trade under higher volume tend to have smaller bid-ask spreads, while those that are thinly traded often have larger bid-ask spreads.
 
Because many pairs trading strategies rely on exploiting very small price changes, the technique may be most efficient for traders who are well-capitalized and who have the ability to enter large positions (i.e., lots of trading capital and willingness to leverage positions). True to nearly any style of investing, smaller traders may need to take a different approach (and employ a different strategy) than the large, institutional pairs traders.

Advantages of Pairs Trading

  1. Pairs Trading: Introduction
  2. Pairs Trading: Market Neutral Investing
  3. Pairs Trading: Correlation
  4. Arbitrage and Pairs Trading
  5. Fundamental and Technical Analysis for Pairs Trading
  6. Pairs Trade Example
  7. Pairs Trading: Risks
  8. Disadvantages of Pairs Trading
  9. Advantages of Pairs Trading
  10. Pairs Trading: Conclusion
RELATED TERMS
  1. Systematic Manager

    A manager who adjusts a portfolio’s long and short-term positions ...
  2. Unconstrained Investing

    An investment style that does not require a fund or portfolio ...
  3. Tactical Trading

    A style of investing for the relatively short term based on anticipated ...
  4. Gross Exposure

    The absolute level of a fund's investments.
  5. Fintech

    Fintech is a portmanteau of financial technology that describes ...
  6. Indicator

    Indicators are statistics used to measure current conditions ...
  1. What happens to the company stock if a subsidiary gets spun off?

    Learn what happens to a company's stock if a subsidiary gets spun off. Spinoffs are typically bullish catalysts for a company ...
  2. What Book Value Of Equity Per Share (BVPS) ratio indicates a buy signal?

    Find out more about book value of equity per share, what BVPS measures and how to determine what level of BVPS indicates ...
  3. How do I evaluate a debt security?

    Look at a brief overview of the important factors to consider before purchasing a debt security, such as a corporate or government ...
  4. What are some tactics businesses can use to increase unlevered free cash flow?

    Learn about ways firms increase their unlevered free cash flow through inventory management, capital expenditures, increased ...

You May Also Like

Related Tutorials
  1. Investing Basics

    Industry Handbook

  2. Fundamental Analysis

    Discounted Cash Flow Analysis

  3. Fundamental Analysis

    Ratio Analysis Tutorial

  4. Active Trading Fundamentals

    Introduction to Stock Trader Types

  5. Trading Strategies

    Top Investment Trends For 2013

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!