Pairs Trading

Pair’s Trading; indeed the hedge fund strategy that Minc is employing was pioneered in the 1980’s by Gerald Bamberger. Bamberger found that certain securities, often competitors in the same sector, were correlated in the day-to-day price movements. When correlation broke down, i.e. one stock traded up while the other traded down, they would sell (short-sell) the outperforming stock and buy the underperforming one looking for the ‘spread’ between the stocks to converge.

“In a pair’s trade, you are not making a bet on the direction of the stocks in absolute terms, but on the direction of the stocks relative to each other “

It is rarely in the best interest of investment bankers and mutual fund managers to share profitable trading strategies with the public, so the pair’s trade remained a secret of the pros (and a few deft individuals) until the advent of the internet. Online trading opened the lid on real-time financial information and gave the novice access to all types of investment strategies. It didn’t take long for the pair’s trade to attract individual investors and small-time traders looking to hedge their risk exposure to market movements.

“Pair’s trading seeks to exploit short term inefficiencies in the market”

 

 

The graph above pictorially illustrates the divergence between WBC and CBA.  In this case we would be looking to short CBA versus a long in WBC.

 

*Please note this is only one parameter of determining an entrance to a trade. Correlation matrices, underlying fundamentals, liquidity measures are some example of further analysis required