#TradingPairs101

Imagine two businesses operating in the same market, running the same strategies, and offering similar products. Although they’re competing with each other, their earnings and stock performancetend to move in sync. Both are highly correlated; it’s almost like they’re tethered together.

When one stock moves up or down, the other tends to follow suit. One stock may significantly jump ahead or fall behind the other (i.e., fall out of correlation), but such anomalies have, historically, turned out to be short-term blips. In a matter of time, their movements end up converging.

This high degree of correlation, suggesting that one stock will always (eventually) catch up with the other, is at the heart of a strategy called pairs trading.