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Is Daily Pairs Trading of ETF-Stocks Profitable?

Last Updated on 10 February, 2024 by Rejaul Karim

Chrilly Donninger’s exploration, “Is Daily Pairs Trading of ETF-Stocks Profitable?” delves into the contemporary viability of the age-old pairs trading strategy. Published in 2016, the paper challenges the conventional belief in the strategy’s historical success, focusing on its applicability in today’s dynamic market landscape.

Donninger narrows down the scope by defining eligible pairs based on the holdings of a specified ETF. Notably, the efficacy of the strategy hinges on the selection of stocks from ETFs that curate high-quality, low-volatility stocks. Addressing the inadequacy of conventional closeness measures, the paper introduces an innovative zero-crossings approach, demonstrating its superior performance.

However, the strategy’s real-world profitability is contingent upon the impact of assumed trading costs, opening a nuanced discourse on the practicality of daily pairs trading in contemporary financial markets.

Abstract Of Paper

Pairs trading is a venerable trading strategy. There is agreement that it worked fine in the far past. But it is less clear if it still profitable today. In this working paper the universe of eligible pairs is defined by the holdings of a given ETF. It is shown that the stocks must be from ETFs which select high-quality, low-volatility stocks. The usual closeness measure presented in the literature performs poor. The paper presents a simple and clearly superior alternative based on zero-crossings. The strategy performs with the correct universe and the improved pairs selection rule before trading costs quite fine. It depends on the assumed trading costs if this is also in real-trading life the case

Original paper – Download PDF

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Author

Chrilly Donninger
Nimzowerkstatt OEG

Conclusion

In summary, our examination of daily pairs trading involving ETF-stocks provides valuable insights into the strategy’s contemporary profitability. While acknowledging its historical success, the key question revolves around its effectiveness in today’s dynamic market landscape.

By defining eligible pairs through a specific ETF’s holdings, focusing on high-quality, low-volatility stock selection, our study uncovers nuanced considerations for optimal pairs. Contrary to conventional closeness measures, our proposed method based on zero-crossings emerges as a superior alternative.

Preliminary results, absent trading costs, indicate promising performance, contingent on the real-world impact of transaction costs. This work contributes to the ongoing discourse on pairs trading, emphasizing the necessity of adapting strategies to current market conditions.

Related Reading:

The Profitability of Pairs Trading Strategies: Distance, Cointegration, and Copula Methods

Selection of a Portfolio of Pairs Based on Cointegration: A Statistical Arbitrage Strategy

FAQ

Q1: How does the study redefine eligible pairs in the context of daily pairs trading involving ETF-stocks?
A1: The study redefines eligible pairs by anchoring them to the holdings of a specific ETF. This innovative approach narrows down the scope and focuses on selecting high-quality, low-volatility stocks from ETFs, challenging conventional beliefs about pairs trading. The research introduces a unique zero-crossings approach as a superior alternative to traditional closeness measures for optimal pair selection.

Q2: What are the key findings regarding the strategy’s performance in today’s market landscape?
A2: The preliminary results of the study indicate that the daily pairs trading strategy, when implemented with the correct universe and improved pair selection based on zero-crossings, performs well before accounting for trading costs. The effectiveness of the strategy in real-world scenarios is contingent upon the impact of assumed trading costs, opening a nuanced discussion on its practicality in contemporary financial markets.

Q3: How does the paper contribute to the ongoing discourse on pairs trading strategies?
A3: The research by Chrilly Donninger contributes to the ongoing discourse by providing insights into the contemporary viability of daily pairs trading involving ETF-stocks. By addressing the historical success of the strategy and adapting it to current market conditions, the study underscores the importance of considering high-quality, low-volatility stock selection and introduces a novel zero-crossings approach, adding valuable considerations to the discussion on pairs trading.

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