Pair Trading was once called a holy grail of Wall Street. The trading strategy was kept under the wraps for so many years; and in the meantime, profited many small companies to turn into big empires, including Morgan Stanley.
The popularity of Pair Trades strategy quickly gained traction among various hedge funds, insurance companies and large banking institutions. With the arrival of internet, the strategy became more accessible to people and is now widely implemented in stocks, indexes, futures, options, as well as forex trading.
What is Pairs Trading?
Pairs Trading is a less-risky, more neutral market trading strategy which is based on the phenomenon of two historically correlated securities. For instance: the stocks of soft drink giants Coca Cola and Pepsi are two potentially correlated pairs, which have generally dipped and surged almost identically. However, there are also times when demand of Coca Cola rises, influencing its stock value to discontinue mimicking the Pepsi stock. This temporary shift brings out an opportunity for trades to sell the Coca Cola stock and buy the Pepsi one, assuming that both the stocks will correct themselves to reform the good-old balance.
Therefore we can state: Pairs Trading is a phenomenon that enables traders to earn