Pair trading - short / long the spread Uuтx Iit ДoIiWl M D w XVv t16Hh Lh q
I am wading into pair trading concepts. Here is one article I've read.
I understand for these strategies our intention is to go long on one asset and short another, however I do not understand what is meant by
long the spread
and
short the spread
My guess:
"long the spread" is when we anticipate the pair is converging. Short the overperformer, and long the underperformer.
"short the spread" is the opposite; we anticipate the pair to diverge, so long the overperformer and short the underperformer?
2 Answers
first keep in mind how spread is constructed, say it's $y - \\beta x$, $y$ being asset $A$'s price and $x$ being that of asset $B$. Then long the spread is when $A$ is under-performing, because our current spread is smaller than "fair value". Short the spread is when $A$ is over-performing.
we always short the overperformer and long the underperformer.
From the link in your OP, the article is talking about buying one stock versus shorting the other. The distance pair trading system they are describing always plays the distance to converge. It just depends on which stock price has appreciated more.
For example, if "stock 1" has moved up excessively compared to "stock 2", you would short "stock 1" and buy "stock 2". If "stock 2" moved up excessively compared to "stock 1" you would short "stock 2" and buy "stock 1".
Whether or not you call this "long the spread" or "short the spread" depends on which stock you have labeled "stock 1" or "stock 2". It's important to understand that the naming of the trade doesn't mean anything, nor does it affect the mechanics of how you are trading. It's just a name.
