- A market-neutral trade comprises of opening long and short positions at the same time to incompetent valuing between crypto-assets.
- At present, market-neutral strategies prove outstanding for the highly unpredictable crypto markets.
- One of the major advantages of market-neutral strategies is an emphasis on building portfolios of traders to ease the market risk.
In a recent case study by Binance research, we have come across the term, constructing a synthetic trading pair which means a combination of long and short positions. It is now to explore the applications of synthetic trading pairs by developing trading strategies.
This offers a unique way of creating alpha across the crypto ecosystem which is a very popular strategy among professional traders in traditional finance. It often delivers nonrelevant returns to the general market. This strategy is known as market-neutral trading.
What is market-neutral trading?
A market-neutral trade comprises of opening long and short positions at the same time to incompetent valuing between crypto-assets. The profit is determined by the price change between the two assets instead of the direction of each asset moves.
At present, market-neutral strategies prove outstanding for the highly unpredictable crypto markets. However, these strategies are risky, unlike traditional arbitrage. That means the strategy offers many benefits which in turn gives maximum profit to the trader without increasing coverage to risk.
How traders get the advantage of this?
Various benefits are offered to a trader’s portfolio by market-neutral trading. It includes diversified strategies apart from directional strategies, the capability to lessen portfolio instability, and warning against a market decline.
One of the major advantages of market-neutral strategies is an emphasis on building portfolios of traders to ease the market risk. In an unstable market, market-neutral strategies are expected to overtake other strategies.
Categories of market-neutral strategies
There are many variations of market-neutral strategies. The classification is based on the sub-set of market-neutral strategies, precisely mean-reversion strategies that are applicable across crypto markets. They are as follows:
- Basic Trade (Futures and Everlasting swaps)
- Statistical Arbitrage (quantitative methods to uncover price discrepancies between two or more crypto-assets)
Risks in Market Neutral Trading
Though Market Neutral Trading contributes exceptional benefits like reduced portfolio volatility, diversification, but it is not risk-free. Before deploying these strategies, the traders must know about the risks and drawbacks.
- Execution Risk– At present, price movements are sharp and rapidly changing which may affect the execution of these strategies as a challenge In the volatile market.
- Correlation/Cointegration failure– For traders, it is important to be updated about the correlation between fundamental factors with individual price movements of crypto-assets. If this occurs, a pair trade will become sour as the direction of assets has changed than expected.
- Price Filling- Earning in pairs-trade often relies on very shrill margins, hence there is a significant risk that orders will not be filled at the preferred price when opening or closing positions in a pairs-trade.
A well-structured market-neutral strategy can offer the trader with excess returns irrespective of the fluctuations in the crypto markets. Thus, it helps as a safeguard for the traders from market crises and episodes of discomforting volatility.