A pair trade is an investment strategy that involves buying and selling two related financial instruments simultaneously in order to profit from the difference in their prices. The goal of a pair trade is to take advantage of pricing discrepancies between two similar assets, while minimizing exposure to overall market movements.
In a typical pair trade, the investor identifies two assets that have a high correlation with each other, such as two stocks in the same industry or two exchange-traded funds (ETFs) tracking the same market sector. The investor then takes a long position in one of the assets and a short position in the other, with the expectation that the long position will increase in value while the short position will decrease in value.
The advantage of a pair trade is that it is designed to reduce overall market risk since the strategy is based on the relative performance of two assets rather than the broader market. Pair trades can be executed using a variety of financial instruments, including stocks, options, futures contracts, and ETFs.
