#TradingPairs101 In pairs trading, a trader buys one asset and simultaneously sells another, anticipating that their prices will converge after a divergence. This strategy relies on the assumption that two correlated assets, which have temporarily drifted apart, will eventually return to their historical correlation. 

Key Concepts:

Correlation:

Pairs trading focuses on assets that exhibit a high degree of historical correlation. 

Divergence:

The strategy is initiated when the prices of the two correlated assets deviate from their historical relationship. 

Convergence:

The trader bets that the prices will eventually return to their normal relationship, allowing the trader to profit from the price difference. 

Shorting:

One asset is bought, while the other is sold short, meaning the trader bets on the price of that asset to decrease. 

How it Works:

1. Identify Correlated Assets:

The trader finds two assets with a strong historical correlation, such as stocks in the same industry. 

2. Detect Divergence:

The trader monitors the relationship between the prices of the two assets and identifies a significant divergence from their historical norm. 

3. Initiate Trade:

The trader buys one asset and simultaneously sells short the other asset, anticipating a convergence. 

4. Profit from Convergence:

As the prices converge, the trader closes the trade, making a profit from the price difference between the initial trade and the final trade.