#TradingPairs101 The "pairs trading" is an investment strategy that involves opening simultaneous positions in two correlated assets, seeking to profit from the price difference between them. Essentially, it is based on the idea that if the prices of two correlated assets diverge, they will eventually converge, allowing the investor to profit by closing the positions.

How it works:

1. Identification of correlated pairs:

The goal is to identify two assets (stocks, indices, currencies, etc.) that have historically moved similarly.

2. Correlation analysis:

Technical and fundamental analysis is used to assess the relationship between the prices of the assets and determine if the current difference is significant.

3. Long and short position:

One buys an asset (long position) and sells (short position) the other correlated asset in a proportion that is considered optimal.

4. Divergence and convergence:

It is expected that the prices of the assets will diverge temporarily but then converge again.

5. Closing positions:

The long position is closed (by selling the purchased asset) and the short position (by buying the sold asset) when the prices converge, profiting from the price difference.

Example:

Let’s say you identify two companies (A and B) with high correlation, but the price of A's stock is currently above that of B, which could indicate a divergence. You can then:

Buy the stock of A (long position) and short sell the stock of B (short position).

Wait for the prices to converge, meaning that A's stock goes down and B's goes up.

Close the positions by buying the shares of B and selling those of A, profiting from the price difference.