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What is a pairs trading strategy?

A pairs trading strategy is a means of taking a market-neutral position by finding two assets with a high correlation that are currently trading outside of their normal range. To perform a pairs trade, you’d go short on the asset that’s trading above the historical range and long on the asset that’s trading below it.

Does pairs trading work?

Pairs trading can work but you’ll need to have a lot of historical analysis backing any decisions up. The two assets need to have a high positive correlation that is confirmed over a long period of time. Once this correlation falters, that’s when a pairs trade can be deployed, to take advantage of the move back to the historical pattern.

What is the principle of pairs trading?

The principle of pairs trading is remarkably simple. An investor finds assets whose prices moved together historically, open a trade by shorting the winner and buying the loser when the spread between them widens. The trade is closed when the spread converges. But while it may sound simple, the devil is in the details!

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