Stemming from observations in previous articles, traders face issues such as operational complexity, capital inefficiency, and custody concerns when executing pair trades on CEXs and DEXs alike.
Pear Protocol aims to solve these challenges by offering a streamlined and decentralized platform for pair trading. To get more context, one can read the previous articles present in the education hub on our platform.
Introduction
Pair trading has gained traction in the crypto market as traders seek different strategies to navigate the ongoing trends and narratives. However, this approach demands a comprehensive understanding of market dynamics and risk management principles.
With Pear Protocol in mind, we delve into essential considerations for tradoors looking to optimize their pair trading strategies
1 - Choose Which Asset to Long/Short
The success of pair trading hinges on selecting the right assets/pair to trade. D’uh!
You can utilize market trends, fundamental analysis, and technical indicators in determining which assets to long and short simultaneously. The asset picked for the long leg, must show comparative strength against the asset picked for the short leg.
For instance, The golden trick on Crypto Twitter back in the day used to be long whatever Hsaka has tweeted about, and short whatever Bitboy shills after the first pump.
2 - Which Asset Moves Faster?
Understanding the correlation between paired assets is paramount. High correlation indicates a strong relationship between assets (good for pair trading), while low correlation suggests muted movement with respect to each other (bad for pair trading).
One way to find an outperformer is also to go through a spaghetti chart, it helps to find the faster horse.
With time more and more traders have started using Pair Charts, which signify strength against the denomination. For instance, here is an ETH/BTC chart which comes in handy when making a correlation between the two assets. The previous PA shows it to be an excellent region to bounce. Hence, initiating a long position on Ethereum (ETH) while concurrently shorting Bitcoin (BTC) may be deemed judicious for capturing the anticipated upward movement in the market.
Pairing assets with a balanced correlation can enhance your trading risk/reward, while mitigating risk.
3 - Deciding The Degree Of Leverage
Leverage amplifies trading positions' exposure to market fluctuations, increasing both profits and losses. Always consider the downside risk. A rule of thumb is to push the leverage button to the west while entering a position before confirmation of your levels. Bet more, and push the leverage button to the east once you have had confirmation/reclaim aligning with your trade direction.
Opting for conservative leverage can safeguard against excessive risk exposure, promotes long-term growth, and can be perfect for your PNL curve.
4 - Net Funding
If you are active on Crypto Twitter, you must have seen many refer to these funding heatmaps to figure out the signs of froth in the market.
Funding is simply the cost of you holding a long/short position. In pair trading, you pay funding on one leg and receive on the other. Net Funding is the cumulative of funding for both the legs involved in pear trading, it makes it a necessary factor to consider when pair trading. We can calculate the same as follows-
you pay the funding rate to be long (A)
you receive the funding rate to be short (B)
net funding = A+B
e.g. ETH above
-0.038% (pay) + 0.006% (receive) = -0.032% on the notional every 8h
These can be indicative/expected levels.
5 - Market & News Induced Volatility
In the trenches of the bear market, we all saw Gary Gensler coming for the crypto industry, and at times coming for particular projects as well. These types of events can induce market volatility and can affect your pair trading as well. For instance, you being a sophisticated trader have sniped what you believe to be the pico bottom of ETH/BTC, and have longed it. Next day, Gary Gensler is on CNBC talking about how he plans to launch a campaign to classify Ethereum, the second-most popular cryptocurrency, as a security. Not only, the market will react to the news, but also affect your current running pair trade. Therefore, it is necessary to keep a track of news around the coins you trade in a pair, and lookout for the events which can cause extreme market volatility.
Above are the most essential things to consider before entering your pair trade on Pear Protocol.
Summary
Consideration #1 - Choose Which Asset to Long/Short
Consideration #2 - Which Asset Moves Faster?
Consideration #3 - Deciding The Degree Of Leverage
Consideration #4 - Net Funding
Consideration #5 - Market & News Induced Volatility
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