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I'm setting up and following a pair trading operation by the method of summing the distances squared (SSD). After determining the best pairs, I have to track the spread between the normalized prices.

Am I noticing something that is bothering me or am I doing it wrong?

When I opened the transaction it is not cash neutral: the long goes, for example, \$26,628.00 and the short goes \$ 29,886.00.

This way it is not a neutral cash trade.

Whatching the Spread between normalized prices, can there be situations where my spread is moving towards the mean(further away from the average) and I have losses?

The fact that my trade didn open as a cash neutral can offer me situation like this? Where I will have to wait until the mean-reverting process complete?

PS: 1)so the spread will depend on the amount of stocks I bought and the size of their prices. That would have influence on the behavior of the spread, right?

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Of course. Even if you started dollar neutral, the spread can continue to move away from its mean resulting in losses. Pairs trading isn't an arbitrage situation, it simply asserts that given correlated assets, their spread will revert to the long run mean if and when it does deviate.

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    $\begingroup$ @Chris many thanks! My question arose because I am following the chart of the normalized spread. and when he pointed in the direction of the mean, it gave me no gain. Thanks to your answer I understood that I do not have to set a stop gain when my normalized spread reach zero (fully revert to average). So what we need to do is "capture" the change in spread. Entering when the spread is 2 standard deviations from the average the chance increases. Am I right? $\endgroup$ – Laura Oct 9 at 13:03
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    $\begingroup$ @Laura, that's the general idea, yes. That's part of the variability of a strategy like that though. There's a risk to setting your entry point to be something like 2SD because you'll miss out on some opportunities, and yet strength of mean-reversion may not be sufficiently strong if you enter at 1SD. Not to mention, you're suffering losses as long as your spread continues to move away from its mean, which can be an issue if you're highly levered. $\endgroup$ – Chris Oct 9 at 22:48
  • $\begingroup$ amzing. Thanks for your time! $\endgroup$ – Laura Oct 11 at 13:23

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