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The pair trading strategy is a market-neutral approach that helps traders to benefit from the historical price relationships between two related assets. It’s about buying and selling two assets simultaneously. These assets usually maintain a stable price relationship, and traders profit from temporary price deviations. This article offers a comprehensive insight into the pair trading strategy with examples and applications to enhance your trading skills.

Decoding Pair Trading

Pair trading hinges on the fact that certain assets, like stocks from the same industry or commodities, maintain a historical price relationship. This relationship remains stable over time. Traders watch out for temporary deviations from this historical relationship. They then take long and short positions on the respective assets, expecting the price relationship to revert to its usual pattern.

Key Elements in Pair Trading

Price Relationship: This is the historical price relationship between two related assets, expected to remain stable over time. Temporary Deviations: These are short-term price discrepancies between related assets. These deviations provide profitable opportunities for pair traders. Market-Neutral Approach: Pair trading is a market-neutral strategy. It involves taking both long and short positions, reducing exposure to overall market movements.

Examples of Pair Trading Strategies

Stock Trading: A trader spots two stocks in the same industry with a strong historical price relationship. If one stock temporarily becomes overvalued compared to the other, the trader may sell the overvalued stock and buy the undervalued one. The expectation is that the price relationship will return to its historical norm. Commodity Trading: A trader observes a temporary deviation in the price relationship between two related commodities, such as gold and silver. The trader may take long and short positions in the respective commodities, expecting the price relationship to return to its historical average.

Pair Trading Applications

Pair trading is applicable across various asset classes and market conditions. Here are some applications:

Risk Management: Pair trading strategies can help traders manage risk. The market-neutral approach reduces exposure to overall market movements. Portfolio Diversification: Pair trading can diversify trading strategies and potentially boost overall returns, making it a valuable addition to a trader’s toolbox. Statistical Arbitrage: Pair trading seeks to profit from temporary price discrepancies between related assets. It’s a form of statistical arbitrage based on the historical price relationship. Long-Term Trading: Pair trading fits both short-term and long-term trading but is particularly apt for longer timeframes. Temporary price deviations may take time to revert to the historical relationship. Algorithmic Trading: Many pair traders use algorithmic trading systems. These systems help identify suitable asset pairs, monitor price relationships, and execute trades based on predefined criteria. They increase the efficiency and precision of trading strategies.


Pair trading is a potent market-neutral strategy. It helps traders to profit from temporary price deviations between related assets. With long and short positions on respective assets, traders can potentially profit when the price relationship reverts to its historical norm. Suitable for various asset classes and market conditions, pair trading adds value to a trader’s toolbox, offering risk management, portfolio diversification, and the potential for enhanced returns.

Go here for a working QuantConnect Pair Trading script.

Books for Further Reading

  1. Pairs Trading: Quantitative Methods and Analysis” by Ganapathy Vidyamurthy
  2. Algorithmic Trading and DMA” by Barry Johnson