Trading in pairs

This contribution is from Tanmoy Neog, who recently completed his masters in Financial Mathematics from the University of Warwick.

"We see that the two stock price series in the first diagram display a lot of co-movement. Can we take advantage of the co-movement of stocks to build a trading strategy? In fact we can. By taking appropriate amounts of the two stocks we obtain the second diagram."

"We observe that we can now sell one stock and buy another simultaneously at certain time intervals to register a profit. This strategy is based on the premise that certain portfolios of stocks have a long run equilibrium value. Due to speculative trading on individual stocks there is a deviation from this value. We take advantage of this fact!!"

"These stocks are in fact Infosys and Wipro on the Bombay Stock Exchange!!"

The job of mathematics is to create ways of identifying such co-movement and the appropriate combinations which will allow this strategy to work...