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What is Pairs Trading: Introduction to Crypto Pairs Trading 

2021-11-30 10:26:09

Pairs trading is a crypto trading strategy that involves opening a simultaneous long and short position on two crypto pairs. Pairs trading is a market-neutral trading strategy and evens out the risk of a trade going wrong by longing one pair and shorting another one.

A trader could place a long order on Bitcoin (BTC) and a short order on Ethereum (ETH) and close one trade when it starts underperforming. This is a market neutral trading strategy for traders to hedge their trade and minimize their losses in the volatile crypto market.

pairs trading

How Pairs Trading Works?

A pairs trading strategy is implemented based on the correlation between two pairs or values on the exchange. These pairs are often a crypto versus a stablecoin such as BTC/USDT. To make a functioning strategy, a trader needs two pairs that they will long and short simultaneously.

Pair trading originated in the 1980s on Wall Street as a hedging method but is commonly used on the crypto market. The strategy is most efficient when there is a discrepancy between two pairs.

At the start of a trade, the pairs are even and produce equal profits. Once the pairs deviate from each other and the trader finds one pair outperforming the other, the underperforming pair is cut off and the profitable pair is retained. The profit is made when the winning trade pair makes a profit and the trade is closed.

For example, if a trader longs the BTC/USDT pair and shorts the ETH/USDT pair, and the BTC long is successful, they can close the ETH short and continue with the BTC long until they close the trade. They effectively hedged their trade and cut off the underperforming trade once it started generating negative balance.

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Example of Crypto Pairs

Trading pairs allow you to compare the performance between different cryptos on the market. For example, every crypto listed on Phemex has a pair to illustrate the current value of the coin. The USDT stablecoin is used to indicate the value of the crypto compared to USD.

The BTC/USDT pair is one potential pair that a trader could long or short. The following is a list of the top 5 pairs on Phemex by volume:

Phemex highest volume pairs
The highest volume pairs on the Phemex marketplace.

Phemex currently offers 37 trade pairs and 38 futures contracts. If a trader opens a long position on one of the altcoins listed above, such as Solana (SOL), but they only have Bitcoin, they can use the conversion tool to convert their balance and open two simultaneous trades.

If you own one crypto, use the Crypto Converter to split the balance between two different cryptos to open a long and short on their respective USDT pairs.

If a trader measures the crypto value in Bitcoin units, or satoshis (SATs), this will indicate how their altcoins performed compared to Bitcoin over many months. Conversion to SATs can help them strategize a successful trade when they’re starting a pair trade. The CoinGecko calculator is one handy tool to find out the SAT value of a coin.

Starting a Pair Trade

To start a pair trade, you need a base currency. A base currency is a currency that sets the value for the trade. To trade on Phemex, you must deposit USDT or crypto. Tether (USDT) is the base currency for most pairs trading. Navigate to the “Deposit” section of the user panel and deposit USDT or crypto from your wallet before you start a trade.

If you don’t have access to crypto, you can purchase directly using the tools in the “Buy Crypto” section. Partners such as Simplex and Moonpay make it easy to purchase USDT using a credit card, allowing you to trade.

There are also options to pay using ApplePay and OTC Trading service including SEPA for EU citizens. Once you have successfully deposited a base currency, you can move on to selecting the best pairs to trade.

4 Best Crypto Pairs to Trade

The best pairs to trade are pairs with high liquidity, large market cap, and great volume. To minimize your trading risk, you should opt for pairs involving cryptos that rank highly by market cap, such as BTC/USDT, ETH/USDT, ADA/USDT, or SOL/USDT.

These pairs are listed on Phemex and all major exchanges, allowing you to easily sell them should the trade go wrong. While the crypto market is volatile, higher market cap coins such as Bitcoin are more liquid than altcoins and less prone to +/-50% daily price shifts.

Volume matters when you’re selecting a trade pair. If more people are trading crypto, you’ll find it easier to sell in large quantities. At the moment, the 24h volume for Bitcoin is $250M USDT. The second largest pair is ETH/USDT at $25M USDT. The following pairs are relatively safe bets:

  • BTC/USDT: Bitcoin (BTC) is the highest market cap crypto with highest amount of trade volume and liquidity on Phemex. The only negative is the high transaction fees if you withdraw, but trade fees are free for our premium members.
  • ETH/USDT: Ethereum (ETH) is the second largest crypto by market cap and the most commonly traded pair on Phemex aside from Bitcoin. Ether is also used for DeFi trades on decentralized exchanges and has the highest number of transactions of any blockchain.
  • SOL/USDT: Solana (SOL) hovers between the 3rd and 4th place by market cap and was one of the top performers during the last bull run. It is highly liquid and the transaction fees are the lowest.
  • ADA/USDT: Cardano (ADA) is one of the fastest rising cryptos and has the highest amount of coins staked of any PoS crypto, making it among the most decentralized. The trade pair has high liquidity and the transaction costs are low.

Liquidity is important if you need to sell large amounts of a certain token. These tokens will always have the highest USDT liquidity on Phemex, making them the best pairs to pair trade. The top 10 cryptos by market cap are always the safest bet because they are a lot less volatile compared to cryptos of a lower market cap.

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What are the Risks of Pairs Trading?

The main risk of pair trading is that the strategy could backfire if the trader chooses the wrong pair or is not attentive to price changes. This is especially the case for traders using leverage for margin trading and futures. Another risk is losing out on potential gains by hedging in a bull market, because holding can prove equally as profitable as trading a coin.

A successful trader has to research the pairs thoroughly and it requires extensive experience, researching historic prices, analyzing price charts, following the news, and planning the trades. This strategy is only recommended for professionals who have a deep understanding of the crypto market.

If you choose to try a pairs trading strategy, make sure to stick to high-volume, high-liquidity pairs such as BTC/USDT. A large price drop such as -80% is not as likely on Bitcoin as it is on other altcoins. As there is more money invested in Bitcoin, and the market cap is larger, it is more stable than other cryptos.

Pair Trading Strategy: How to Trade

To start a trade, you must do in-depth research of the pairs you’re trading. For example, you can trade Bitcoin vs. Ethereum, Cardano vs. Solana, Ethereum vs. Link, and other coins. To understand how these potential pairs correlate, you can use tools such as the Coinmetrics correlation chart.

This demonstration uses Coinmetrics correlations. The first pair selected is BTC/ETH, which has a correlation chart of 0.81 at the time of writing:

btc eth pair trade
Correlation between BTC/ETH (Source: Coinmetrics)

We can notice that the discrepancy between Bitcoin and Ethereum has evened out during the last few years and it was huge between 2016-2018 when Ethereum launched and Bitcoin was outperforming Ethereum. This chart would show if there are long opportunities and disparities between their performances.

The same metric can be applied for other crypto trade pairs. For example, we can compare how Cardano performed compared to Ethereum. According to this chart, Ethereum is outperforming Cardano in November 2021:

ada usdt pair trade
Correlation between ADA/USDT (Source: Coinmetrics)

If a trader believes that Cardano will pick up the pace and outperform Ethereum in the immediate term, they can start a simultaneous long order on the ADA/USDT pair and a short order on the ETH/USDT pair.

Phemex customers can also use trading bots to set up automated trades for different pairs based on the data they have available.

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The crypto market is volatile and can surprise even the smartest traders. One way to minimize risk in the markets is to use market-neutral trade strategies to hedge your trade, such as trading pairs. Using pairs trading, traders can find profitability in all market conditions.

Pairs trading is one of the simplest hedging techniques. A trader only has to pick two pairs and start long and short trades simultaneously. Initially, the trades will be evened out, and when they start diverging the trader can cut off the underperforming trade and maximize their profits on the successful trade.

The best pairs for trading are highly liquid pairs such as BTC/USDT, ETH/USDT, and other high-market-cap cryptos. These pairs are unlikely to experience as much price volatility as lower-market-cap coins, and they are also the most liquid, allowing a trader to profit even during a market downturn.

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