Pairs Trading

Core idea

Pairs trading takes opposing positions in two related instruments when their spread departs from an estimated normal range. The thesis is convergence in the relationship, not a forecast that both prices will move in one direction.

Implementation

A useful pair needs a stable relationship, a defensible entry rule, and enough expected convergence to cover both legs’ costs.

Primary risk

A historical relationship can break permanently, so a widening spread is not automatically a better entry.

Frequently asked questions

What is pairs trading?

Pairs trading takes opposing positions in two related instruments when their spread departs from an estimated normal range. The thesis is convergence in the relationship, not a forecast that both prices will move in one direction.

What is the main risk of pairs trading?

A historical relationship can break permanently, so a widening spread is not automatically a better entry.