Education: The mighty pairs trade

I’ll be the first to admit I have no clue what direction the market is going in right now, but that doesn’t mean I want to sit out. No matter how crazy the economy on the whole is, some companies are strong, while others are weak. Just because the market can sink or raise both doesn’t men I should be completely afraid.

Enter pairs trading.

When you trade pairs, you are betting on two stocks in the same industry and sector at the same time: one that you think highly of you buy long while you go short (sell borrowed shares) on one you think is not long for this Earth. This works because you have both long and short positions, so if the market takes a tumble or makes a gain regardless of the economics of the stock, your two positions cancel out. In essence, their similarities make their differences safer to play.

Since the market can move stocks more than their own companies can (the last couple of weeks have shown that) this strategy can be a boon for traders looking to get some money back on the table without exposing themselves to much to mean old Mr. Market.

Just remember it is important to pairs trade with companies that are in very similar industries. You don’t want news that only affects one moving the stocks: it’s an all or nothing proposition.

If you want more information on pairs trading, check out Investopedia’s section on it.