What is Pairs Trading? How does the strategy work?

There are many moving parts to the process, from exchanges to altcoins, and it can take time to keep track of everything. However, some strategies and automated trading tools can help simplify the process and make it more manageable.

In this article, we delve more into one such strategy called ‘Pairs trading’. 

Key Takeaways

• Pairs trading refers to two assets that can be traded against each other
• The BOTS app has a new bot that follows the pairs trading strategy - The Bear Fighter bot
• Pairs trading is relatively low-risk since you can potentially profit from fluctuations on two different assets.
• The strategy still has risks; since it depends on correlation prediction, it can lead to losses if not properly correlated.

What is pairs trading?

Pairs trading in cryptocurrency involves two assets that can be traded against each other.

In a pair, there is a base currency and a quote currency. 

Base currency: This is the first currency listed in a pair - also known as the transaction currency

Quote currency: This is the second currency you will see mentioned in a pair - also known as the counter currency.

How to interpret a pair:

Example: BTC/ETH - Here, the latter refers to the second currency in this currency pair and displays how much of the quote currency is required to purchase one unit of the base currency. The market determines each pair's value and changes depending on the supply and demand for each currency.

Let’s take the same BTC/ETH example to understand this better: 

• In a BTC/ETH pair, BTC is the base currency, while ETH is the quote currency. 
• Let's say the market price of BTC/ETH is 1 BTC = 2 ETH. This means that to buy 1 BTC, you will need to spend 2 ETH.

Cryptocurrency pairs are usually traded on exchanges and can be bought or sold just like any other asset on the platform.

Introducing the Bear Fighter bot

To make this strategy accessible to our users, we are proud to introduce a new bot called the Bear Fighter bot. 

• The Bear Fighter is the first bot of its kind that can go 'short', making the well-known trading strategy called 'pairs trading' possible.
• This bot trades the cryptocurrency AVAX (Avalanche) and another asset that correlates to it.
• According to this strategy, if two assets that are strongly correlated to each other temporarily diverge, they will reunite after a short time. 
• This moment of divergence is an opportunity to trade. 
• Successful pairs trading often requires the right timing and speed.
• With its market-neutral strategy, this bot can be useful when markets are flat or when prices are falling - in a bear market, for example.

Why use pairs trading?

Pairs trading is a strategy that speculates on the relative value of two cryptocurrencies rather than their actual price movements. In other words, in a way, the strategy assumes that one cryptocurrency will outperform another in the future. To do this, you need to identify two assets that strongly correlate with each other. This means that when one asset increases in value, the other usually follows suit.

However, there are times when this relationship breaks down, and the two assets move in opposite directions. When this happens, it presents an opportunity to profit from the price difference between the two assets. To do this, you need to buy the undervalued asset and sell the overvalued one.

You can then wait for the market to correct itself and close your position when the prices of the two assets have converged. This usually results in a profit, although there is always a risk that the price difference will continue to widen and you will make a loss.

Advantages of pairs trading

Pairs trading has a few advantages that make it an attractive strategy, especially for new investors.

• First, pairs trading is a relatively low-risk way to trade cryptocurrency. This is because you’re not investing in just one asset but two. So, even if one of the assets falls in value, the other may rise and offset any losses.
• Second, pairs trading can help you take advantage of market fluctuations. When the price of one asset in a pair rises, the other usually falls, and vice versa. By trading both assets, you can profit from these fluctuations.
• Lastly, pairs trading is a good way to start cryptocurrency trading. You don’t need to worry about keeping track of multiple assets or trying to predict which asset will rise or fall in value. All you need to do is monitor the price movements of the two assets in the pair and trade accordingly.

Cons of pairs trading

This strategy is not without its disadvantages, however.

• First, you need to have a good understanding of both assets in a pair before you trade. This means keeping up with the latest news and developments for both assets, which can be time-consuming.
• Second, even though pairs trading is considered low-risk, some amount of risk is still involved. The price of both assets in a pair can fluctuate wildly, and you could lose money if you’re not careful.
• The pairs trading strategy assumes that the two traded assets are correlated. However, this is not always the case, and there may be times when the assets are not correlated. This can lead to losses if you’re not careful.

To circumvent the risk of doing this yourself, you can instead have automated trading tools do the work for you. Don’t have the BOTS app yet? Download it here!

FAQs

What is a cryptocurrency trading pair?

A cryptocurrency trading pair is two cryptocurrencies that can be traded against each other. It consists of a quote currency and a base currency. The quote currency reflects how much is needed to buy 1 unit of the base currency. In the BTC/ETC pair, ETC serves as the quote currency, while BTC is the base currency.

What is a Crypto-Cross pair?

A Crypto-Cross pair is a trading pair that includes two digital assets. For example, the BTC/ETH pair is a crypto-cross pair.

What is a Fiat-to-Crypto pair?

A Fiat-to-Crypto pair is a trading pair that includes a cryptocurrency and a fiat currency. For example, BTC/USD is a Fiat-to-Crypto pair because it has BTC (a cryptocurrency) and USD (a fiat currency).

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Disclaimer:

This blog is for educational purposes only. The information we offer does not constitute investment advice. Please always do your own research before investing.

Any views expressed in this blog and by BOTS do not constitute a recommendation that any particular cryptocurrency (or cryptocurrency token/asset/index), portfolio of cryptocurrencies, transaction, or investment strategy is suitable for any specific person.