Implementing simplified short-term pairs trading strategy in equity market: understanding the risks of retail investor

This study examines the profitability of a simplified short-term pairs trading strategy for retail investors in real-time equity markets, comparing the performance of individual stock pairs versus clusters of stocks. The research employs a simplified strategy implemented using accessible tools like “eToro” for trading and “MS Excel” for calculations. Stock pairs were selected based on historical correlations. The strategy was tested over a six-week trading period, comparing the performance of individual pairs versus a cluster of pairs. Key risk factors such as market trends, divergence risk, idiosyncratic news, and transaction costs were analysed. The research revealed that while the strategy can mitigate large losses when well-diversified, profitability is limited in stable or rising markets, idiosyncratic events also significantly impacted profitability. Trading clusters of stocks offers greater stability but reduced profit potential, whereas individual pairs provide higher but riskier returns. This research provides practical insights for retail investors seeking the simplified methods for pairs trading. It emphasises the importance of effectively managing key risks, diversifying portfolios, and adjusting trading strategies to improve investment outcomes. By concentrating on real-time market dynamics and a simplified framework, this study distinguishes itself from prior studies by offering practical guidance for retail investors, emphasizing the accessibility and flexibility of its methodology, in contrast to the complex algorithmic methods discussed in other studies.