pairs trading withe residual method

[James Liu]

I have a few questions after reading wiki pairs trading.

https://wiki.pairtradinglab.com/wiki/Pair_Trading_Models#Residual_Model

1) I'm a bit confused as to what you mean by short pair or long pair position during entry as in any case as long as the Z Score is >= or <= to the En then you always go long one leg and short the other leg. Am I missing the definition of the short pair or long pair?

2) Can you or someone say more in regards to the z ask and z bid score? If I am using ask-bid price for trading high frequency, how are the two used for entry and exiting signals? I noticed if I run a pair analysis, there is a graph that shows the ask and bid lines. I would like to understand how that is used.

[admin]

Hi James,

ad 1)
let's assume you trade pair AAA/BBB...to open a long pair position, you buy AAA and short BBB...to open a short pair position, you short AAA and buy BBB

ad 2) there are two Z-scores (ask and bid) because in reality you observe two different price for each stock (bid price and ask price)...so the ask z-score is calculated from ask price of stock 1 and bid price of stock 2 and vice versa