Certain Terms/Abbreviations are used in Pair Trading.  Find below some of the important terms used on this site.

 

Price Ratio (PR)

Price Ratio is calculated by dividing the price of the first stock by the second. Mostly by High value stock by Low value stock

Example: KOTAKBANK-HDFCBANK pair

PR = HDFCBANK / KOTAKBANK

1394.05/804.7 = 1.7324

 

Mean Price Ratio

Is the average Price Ratio for a given period of time

Mean Price Ratio for 60 days = SUM(60 days Price Ratio)/60

 

Spread (SP)

The spread is defined as the difference between the two stock prices.  Spread is calculated by deducting the price of the high value stock by the low value stock.

Spread = KOTAKBANK-HDFCBANK

1394.05-804.7 = 589.35

 

Mean Spread

Is the average Spread for a given period of time.

Mean Spread for 60 days = SUM(60 days Spread)/60

 

Correlation

A correlation is a statistical measurement of the relationship, either positive or negative, between two variables.

Statistical correlation is a statistical technique which tells us if two variables are related.

 

Standard Deviation (SD)

Shows how much variation or “dispersion” exists from the average (mean).

 

Standard Score (Z-score)

A Standard Score indicates by how many standard deviations an observation or “datum” is above or below the mean.

Eg: Z-score of 2  means the PR has moved 2 SD from mean PR

 

Cash Neutrality (CN)

Ratio of funds required between 2 symbols expressed in terms of percentile.

Calculation

Price1 x lot size
———————
Price2 x lot size

Eg: KOTAKBANK-HDFCBANK

KOTAKBANK- Lot Size 800, Future Price – 804.7
HDFCBANK – Lot Size 500, Future Price – 1394.05

804.7 x 800 = 6,43,760
1394.05 x 500 = 6,97,025

643760/697025 = 0.9235, in percentile terms it is 92.35%

means KOTAKBANK is 92.35% of HDFCBANK after taking lot size into account.

 

Current Price Ratio (CPR)

Latest Price Ratio of a pair

 

Trade Initiation Condition (TIC)

TIC is expressed in terms of Price Ratio or Spread at which a trade can be initiated.

 

Target Price Ratio (TPR)

Price Ratio at which Profit can be booked.

 

PR #

PR # means PR should cross the given ratio and on return journey trade needs to be initiated.

Eg: TIC PR # 3.14, CPR 3.11

3.11 is the current Price Ratio at which the symbols are trading.  When the PR crosses 3.14 and goes beyond and when PR comes back to 3.14 then the trade needs to be initiated.  This way we are confirming that there is a trend reversal.