Cryptocurrencies can generally be linked and can move together on trading charts? A ZScore provides insight into how crypto pairs are related. Cryptocurrencies can act in a way where they are mutually dependent. Traders can profit from this relationship when one cryptocurrency has an extreme change in value to another related currency. This is called Pair Trading and it is a trading strategy that matches a long position in one crypto with an offsetting position in another crypto that is statistically related.
Pairs Trading can be called a Mean Reversion Strategy where we bet that the prices will revert to their historical trends. Here’s how you can profit from this:
- Going long on one currency and short on the other.
- Taking a view as to whether you should just go long or just go short depending on your assessment.
- Doing nothing. Backtest yourself using the new pair you have found to see if statistical arbitrage is profitable.
So how do you find these opportunities?
- Calculate the ADF(Augmented Dickey-Fuller) test to find co-integrated pairs.
- Calculate the Hurst exponent to find whether the time series is mean-reverting.
- Calculate the Half-Life which tells how quickly the pair reverts to the mean.
- Calculate the entry & exits are based on Z-scores.