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

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

Related Articles
  1. Investing

    How To Calculate The Bid-Ask Spread

    It's very important for every investor to learn how to calculate the bid-ask spread and factor this figure when making investment decisions.
  2. Investing

    Penny Stocks

    Learn more about this cheap stock and how its high risk nature, large bid-ask spreads and lack of liquidity may not make it the most wise investment.
  3. Trading

    4 Common Active Trading Strategies

    Learn four of the most popular active trading strategies and why active trading isn't limited to professional traders anymore.
  4. Trading

    An Introduction To CFDs

    The benefits of these securities abound, but high leverage also magnifies potential losses.
  5. Trading

    How To Pay Your Forex Broker

    Three types of commissions are used in this market. Learn how to get the best deal.
  6. Trading

    Trading Calendar Spreads In Grain Markets

    Futures investors flock to spreads because they hold true to fundamental market factors.
  7. Trading

    Earn More Profit With Less Trading

    Avoiding overtrading can save your money and your sanity. Find out how to slow your turnover and build your profits.
  8. Trading

    Understanding Financial Spread Betting

    Investopedia explains the logic behing financial spread betting.
  9. Trading

    Forex: Should You Be Trading Trend Or Range?

    In FX, it's not the price environment that decides this for you. Learn the differences to see which you prefer.
  10. Trading

    4 Common Active Trading Strategies

    Active trading entails buying and selling securities with the intent of profiting from short-term price movements.
Frequently Asked Questions
  1. Depreciation Can Shield Taxes, Bolster Cash Flow

    Depreciation can be used as a tax-deductible expense to reduce tax costs, bolstering cash flow
  2. What schools did Warren Buffett attend on his way to getting his science and economics degrees?

    Learn how Warren Buffett became so successful through his attendance at multiple prestigious schools and his real-world experiences.
  3. How many attempts at each CFA exam is a candidate permitted?

    The CFA Institute allows an individual an unlimited amount of attempts at each examination.Although you can attempt the examination ...
  4. What's the average salary of a market research analyst?

    Learn about average stock market analyst salaries in the U.S. and different factors that affect salaries and overall levels ...
Trading Center