How to Find Pairs Trading Opportunities: Screening Methods
Quick Answer
To find pairs trading opportunities: (1) Select a stock universe from the same sector (e.g., S&P 500 banking stocks), (2) Calculate correlations for all pairs and filter for >0.80, (3) Test for cointegration using Engle-Granger method on correlated pairs, (4) Evaluate metrics like half-life (5-15 days ideal), hedge ratio stability, and spread volatility. Manual screening of 500 stocks creates 124,750 pairs—impossible without automation. Use tools like Pair Parade to screen thousands of pairs in seconds.
Screening Methods: Manual vs Automated
Manual Screening (Not Recommended)
Trying to find pairs manually by looking at charts or stock lists:
- Time required: Weeks or months for comprehensive screening
- Accuracy: Low (misses most opportunities, prone to bias)
- Scalability: Impossible beyond 20-30 stocks
- Cost: Free but extremely time-consuming
❌ Problem: Screening 500 stocks manually = 124,750 possible pairs. Testing each for cointegration would take years. This is why automation is essential.
Automated Screening (Recommended) ⭐
Using software to screen and test pairs automatically:
- Time required: Seconds to minutes
- Accuracy: High (tests every pair systematically)
- Scalability: Can screen 20,000+ pairs
- Cost: $0-$100/month (affordable)
✓ Solution: Pair Parade screens 20,000+ pairs daily, tests each for cointegration, and ranks them by quality. You see only the best opportunities.
The Screening Process
Define Your Stock Universe
Start by selecting a group of stocks to analyze. Best practices:
- Same sector: Banking, energy, tech, healthcare, etc.
- Similar market cap: Large-cap with large-cap (avoid mixing sizes)
- High liquidity: Daily volume > 1M shares (for easy execution)
- Index-based: S&P 500, NASDAQ 100, or sector-specific ETFs
💡 Example: Screen all S&P 500 banking stocks (JPM, BAC, WFC, C, etc.) = 20 stocks = 190 possible pairs. Much more manageable than screening everything.
Calculate Correlation Matrix
For each pair, calculate the correlation coefficient over your lookback period (typically 90-252 days):
Correlation Formula:
⚠️ Filter: Only proceed with pairs showing correlation > 0.80. Lower correlations rarely lead to cointegrated pairs.
✓ Automated: Pair Parade calculates correlations for all pairs automatically, saving you hours of computation.
Test for Cointegration
Run statistical tests on highly correlated pairs to verify cointegration:
Engle-Granger Process:
- Convert prices to logarithms
- Run OLS regression: logP₁ = α + β × logP₂
- Extract residuals
- Run ADF test on residuals
- Check if ADF < -3.1 (cointegrated)
✓ Result: Only pairs with ADF < -3.1 pass. Typically 20-30% of highly correlated pairs are actually cointegrated.
Evaluate Additional Metrics
Rank cointegrated pairs by quality using these metrics:
Half-Life
Ideal: 5-15 days. Shorter = faster trades.
Hedge Ratio Stability
β should remain relatively constant over time.
Spread Volatility
Moderate volatility = good trading opportunities.
Zero Crossings
More mean reversion = more opportunities.
💡 Pair Parade Score: Our PP Score combines all these factors into a single quality metric (0-100), making it easy to identify the best pairs.
How Often Should You Screen?
Daily Screening (Automated)
Best practice. Cointegration relationships can change. Daily screening ensures you catch new opportunities and identify when existing pairs break down. Pair Parade does this automatically.
Weekly Screening (Manual)
Acceptable if you're manually screening. You'll miss some opportunities but can still maintain a good portfolio. Not ideal for active trading.
Monthly or Less
Too infrequent. Markets change quickly. Pairs that worked last month may not work this month. You'll miss opportunities and hold onto broken pairs too long.
Screening Criteria Checklist
Use this checklist to evaluate pairs from your screening results:
Same Sector or Industry
Both stocks must face similar market forces
Correlation > 0.80
High correlation is necessary (but not sufficient)
ADF Statistic < -3.1
Strong evidence of cointegration (5% significance)
Half-Life 5-15 Days
Fast enough for multiple trades, slow enough to avoid noise
Large Cap Stocks
Market cap > $10B for liquidity and stability
Stable Hedge Ratio
β should not fluctuate wildly over time
High Daily Volume
Both stocks > 1M shares/day for easy execution
Screening Tools Comparison
| Tool | Pairs Screened | Cointegration Test | Time Required | Cost |
|---|---|---|---|---|
| Manual (Excel) | 10-50 pairs | ✗ No | Weeks | Free |
| Python Scripts | 1,000-5,000 pairs | ⚠ Manual setup | Hours (per run) | Free + data costs |
| Bloomberg Terminal | Unlimited | ⚠ Available but complex | Minutes | $2,000-$3,000/month |
| Pair Parade | 20,000+ pairs | ✓ Automated | Seconds | Free tier available |
Screen Thousands of Pairs Instantly with Pair Parade
Don't waste weeks manually screening pairs. Pair Parade screens 20,000+ pairs daily, tests each for cointegration, and ranks them by quality. You see only the best opportunities, ready to trade.
✓ 20,000+ Pairs Screened
Daily automated screening
✓ Instant Results
See best pairs in seconds
✓ Pre-Validated
Every pair tested for cointegration
Frequently Asked Questions
How many pairs should I screen at once?
Start with 50-100 stocks from 2-3 sectors. This creates 1,225-4,950 pairs—manageable for manual screening, comprehensive for automated. As you gain experience, you can expand to larger universes. Pair Parade screens entire markets automatically, so you don't have to choose.
Can I screen international markets?
Yes, but it's more complex. You need data feeds for international exchanges, handle currency conversions, and account for different trading hours. Most retail traders start with US markets (NYSE, NASDAQ) due to data availability and liquidity. Pair Parade currently focuses on US markets.
Should I screen ETFs or only individual stocks?
Both work. ETF pairs (e.g., SPY vs QQQ) can be very stable but often have lower profit potential. Individual stock pairs offer more opportunities and higher returns but require more careful screening. Many traders use a mix: ETF pairs for stability, stock pairs for returns.
How do I know if my screening is working?
Track your results: (1) Win rate should be 60-70%+ for good pairs, (2) Average profit per trade should exceed transaction costs by 3-5x, (3) Pairs should revert to mean within expected half-life, (4) Stop losses should be hit < 20% of the time. If these metrics are poor, your screening criteria may be too loose.