A Novel Machine Learning-assisted Pairs Trading Approach for Trading Risk Reduction

The cryptocurrency market has been growing rapidly in recent years. The volume of transactions and the number of participants in the cryptocurrency market makes it huge enough that we cannot ignore it. At the same time, the global stock market has also reached a new height in the past two years. However, due to the COVID epidemic and other political and economic-related factors in the last two years, the uncertainty in the capital market remains high, and short-term large fluctuations occur frequently; thus, many investors have suffered substantial losses. Pairs trading, an advanced statistical arbitrage method, is believed to hedge the risk and profit off the market regardless of market condition. Amongst the vast literature on pairs trading, there have been investors trading a pair of cryptocurrencies or a pair of stocks using machine learning or empirical methods. This research probes the boundary of utilizing machine learning methods to do pairs trading with one stock asset and another cryptocurrency. Briefly, we built an assets pool with both stocks and cryptocurrencies to find the best trading pair. In addition, we applied mainstream machine learning models to the trading strategy. We finally evaluated the accuracy of the proposed method in prediction and compared their returns based on the actual U.S. Stock and Cryptocurrency Market data. The test results show that our method outperforms other state-of-the-art methods.