An Advanced Optimization Approach for Long-Short Pairs Trading Strategy Based on Correlation Coefficients and Bollinger Bands

Abstract

In the financial market, commodity prices change over time, yielding profit opportunities. Various trading strategies have been proposed to yield good earnings. Pairs trading is one such critical, widely-used strategy with good effect. Given two highly correlated paired target stocks, the strategy suggests buying one when its price falls behind, selling it when its stock price converges, and operating the other stock inversely. In the existing approach, the genetic Bollinger Bands and correlation-coefficient-based pairs trading strategy (GBCPT) utilizes optimization technology to determine the parameters for correlation-based candidate pairs and discover Bollinger Bands-based trading signals. The correlation coefficients are used to calculate the relationship between two stocks through their historical stock prices, and the Bollinger Bands are indicators composed of the moving averages and standard deviations of the stocks. In this paper, to achieve more robust and reliable trading performance, AGBCPT, an advanced GBCPT algorithm, is proposed to take into account volatility and more critical parameters that influence profitability. It encodes six critical parameters into a chromosome. To evaluate the fitness of a chromosome, the encoded parameters are utilized to observe the trading pairs and their trading signals generated from Bollinger Bands. The fitness value is then calculated by the average return and volatility of the long and short trading pairs. The genetic process is repeated to find suitable parameters until the termination condition is met. Experiments on 44 stocks selected from the Taiwan 50 Index are conducted, showing the merits and effectiveness of the proposed approach.