What is a pair trading strategy?

Pairs trading is a market neutral trading strategy a lot of hedge funds and prop traders take advantage of. Throughout this guide, you’ll learn the fundamentals of pair trading strategy and how to hedge your trades from unforeseen market movements. Pairs trading relies on a mathematical concept known as cointegration.

What is pairs trading?

In other words, pairs trading is a specific type of spread trading where the two assets are highly correlated and the objective is to profit from the temporary mispricing of the two assets. Spread trading can also include other types of spread such as calendar spread, inter-commodity spread, etc.

How does a pair trade work?

The pairs trade is market-neutral, meaning the direction of the overall market does not affect its win or loss. The goal is to match two trading vehicles that are highly correlated, trading one long and the other short when the pair's price ratio diverges "x" number of standard deviations —x" is optimized using historical data.