What is pairs trading?
Pairs trading is a market-neutral trading strategy where traders profit from the relative price movements of two correlated assets. By taking a long position in one asset and a short position in another, traders aim to capitalize on temporary divergences and the subsequent reversion to their historical relationship. The strategy is designed to be market-neutral, meaning it seeks to generate returns regardless of the overall market direction. Success relies on the careful selection of correlated pairs and diligent risk management.
thefreedictionary
An investment strategy in which one owns two stocks in the same industry. In general, these stocks follow the same pattern; that is, both go up or both go down. When the pattern diverges (that is, when one increases in price and the other decreases), the investor sells the stock that has increased and buys the stock that has decreased. The idea behind a pairs trade is that the stocks will generally meet back in the middle, allowing the investor to profit from the purchase of the stock that had decreased and the sale of the one that had increased.
Wikipedia
A pairs trade or pair trading is a market neutral trading strategy enabling traders to profit from virtually any market conditions: uptrend, downtrend, or sideways movement. This strategy is categorized as a statistical arbitrage and convergence trading strategy. Pair trading was pioneered by Gerry Bamberger and later led by Nunzio Tartaglia’s quantitative group at Morgan Stanley in the 1980s.
The strategy monitors performance of two historically correlated securities. When the correlation between the two securities temporarily weakens, i.e. one stock moves up while the other moves down, the pairs trade would be to short the outperforming stock and to long the underperforming one, betting that the “spread” between the two would eventually converge. The divergence within a pair can be caused by temporary supply/demand changes, large buy/sell orders for one security, reaction for important news about one of the companies, and so on.
