Article Guide to Pairs Trading – Part 1

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IntroductionPairs trading is a market-neutral trading strategy that matches a long position with a short position in a pair of highly correlated instruments such as two stocks, exchange-traded funds (ETFs), currencies, commodities or options. Pairs traders wait for weakness in the correlation, and then go long on the under-performer while simultaneously going short on the over-performer, closing the positions as the relationship returns to its statistical norm. The strategy’s profit is derived from the difference in price change between the two instruments, rather than from the direction in which each moves. Therefore, a profit can be realized if the long position goes up more than the short, or the short position goes down more than the long (in a perfect situation, the long position will rise and the short position will fall, but this is not a requirement for making a profit). It is possible for pairs traders to profit during a variety of market conditions, including...
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