Pairs Trading in Crypto | Different Way of Trading

What is Pairs Trading?

Pairs trading is a common way of trading among professional stock market traders. This method gives them relatively less exposure to any market moves while offering numerous different trading set ups.

Let’s take an example of a stock market trader who excels in the banking sector. He may be bullish on the overall banking sector though he may NOT want to take any directional traders ie, direct long exposure.

For the argument’s sake, let’s assume that within the banking sector, Chase is the strongest player in the sector while Wells Fargo has a consistent track record of lacking behind. Instead of putting all the eggs in the same basket and going long on Chase, the trader can go long on Chase and go short on Wells Fargo with the same amount of capital.

This set up provides two distinct edge on other directional traders. If the market takes a sudden down turn, we can safely assume that Chase would suffer less of a loss in value compared to Wells Fargo. On the other hand, if the market starts making new highs, we know that Wells Fargo is likely to lack behind and Chase would lead the market move. Therefore, in both scenario the trader would be hedged in both directions.

Since trading is a zero-sum game, here is the caveat. If the pair loses correlation meaning that Wells Fargo starts to outperform Chase, your position will be underwater. That can be managed through technical analysis and fundamental research. The other issue is that the directional trader who would only go long or short would be making more profits than you are. However, this is a preference in risk tolerance. Because, he would lose more than you would have if the market went into the opposite direction. Pairs trading gives you an edge and possibility to profit if the market goes in either direction. You just have to bet on the right horse or the better performing asset.

Now let’s take a look at how to apply this strategy in cryptocurrency.

How to Apply it to Cryptocurrency?

First, let me point the elephant in the room, if you are trading any alt coin, you are already pair trading. Why? Because, you are ultimately short on Bitcoin and long on the alt coin you are trading. If you are trading BTC/LINK, you are selling Bitcoin for Link which means that you expect Link to outperform Bitcoin. Also, if you are trading LINK/USDT, you expect Link to perform better than Bitcoin. Otherwise, why not just buy Bitcoin, right? But there is more to it!

Now, let’s look at the oracle space in cryptocurrency. We have two major players, Link and Band. You may be bullish on the oracle idea and oracle projects however; you know that Bitcoin may go down and ruin the party. Also, you assume that Link will out perform Band. So, you go long on Link and short on Band. If Bitcoin dumps, Band is going to dump more than Link which means you short position’s profit is more than your long loss on Link. The same idea applies to the other way around, if the market pumps, Link will outperform Band and your long position’s profit will cover the short position’s loss. You can do the same with UNI and Sushi, YFI and YFII or ETH and TRX.

You do not have to pick two coins that are in the same cryptocurrency sector, you can purely trade on momentum bias. For example, ETH historically outperforms XRP or BCH. So, you can go long on ETH and short on XRP. The possibilities are endless. You just have to pick the stronger of the two. If the market dumps, the stronger one will dump less than the weaker one.

How to chart pairs on TradingView: I personally, pick the coin I am bullish on first and divide that by the coin I am bearish on. In this way, if the price of the ratio goes up, I know I am in profit and if the ratio falls I know I am at a loss. For instance, I am bullish on ETH and bearish on BCH. I would go on TradingView and type ETHUSDT / BCHUSDT.

Rules of Pair Trading

1- You MUST use the same size on both trades. If you short A with 10,000$ on 3x leverage, you need to long B with 10,000$ on 3x leverage. You should try to take both positions at the same time.

2- If the exchange auto deleverages one of your positions, you need to close the other position. Otherwise, your position will become a directional trade.

3- If you want to take profit, you need to close the same size on both positions to maintain the same exposure.

4- Calculate fees, pay attention to the funding rate!

Trade it on Binance here: https://www.binance.com/en/register?ref=16711799

Happy Trading!

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