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I cannot take credit for this document as it is a document written by a different author, but I believe it will help you in your request for Pairs Trading.
Last edited by Stocktrading101; 03-09-06 at 12:47 PM.
To be honest the thing that got me interested in this was a thread that posed the question: "If you know that stock A will out perform stock B in a given time frame but do not know if the price will go up or down is there a way to make money on the difference in price?" The answer to that is a definate maybe if you can figure out how to pair trade.
In a nutshell it involves some fairly (extremely) complex calculations on the relation ship between pairs of companies. When the stocks diverge in the relation ship then you short one and long the other betting they will reconverge. The trick is to determine which way they will go to converge IE: the underperformer is long and the over performer is shorted or vice versa. By using this strategy you lock in the potential difference as profit when they reconverge. IE: the over performer goes lower and or the underperformer goes higher to re-establish the relationship. This type of trading is not for the average Joe and is used for the most part by institutional entities.
Wow that was a big nutshell lol
Joe
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