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I'm getting into pairs trading (statistical arbitrage), but I keep finding different instructions on how it's done.

Some sources (like this) run the linear regression (to find hedge ratio) on the log prices of the two assets. Other sources (like this) run the linear regression on the log returns of the two assets to determine hedge ratio.

Which one is the correct way to do it? Is there any good source/guide for pairs trading? All I seem to find are random blogs.

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depends on what you're doing. a quick google search will turn up plenty of results saying that you always want to regress returns against each other (to remove the element of trend), but sometimes you may want to regress prices against each other if trend is the very thing you are testing for

https://hudsonthames.org/definitive-guide-to-pairs-trading/ ^ this is an oft recommended resource, theres also a pairs trading book by vidyamurthy and Ernie Chan has some pairs stuff in his algo trading book. check em out

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  • $\begingroup$ Could you explain what you mean by "if trend is the very thing you are testing for"? I am trying to apply a cointegration-based approach to pairs trading. Also, Ernie Chan is awesome, but I haven't seen him cover this in detail. I'll try to find it! $\endgroup$ Mar 1 at 4:26

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