V. 20:3 (43): Q&A by Don Bright

Q&A by Don Bright

PAIRS TRADING

I read your article and your Q&A section in STOCKS & COMMODITIES this month. In both, you referred to “pair trading.” When I read that it was a strategy used successfully by your niece, I was intrigued. Would you please explain the strategy? — Scott Memmott

Many of our successful traders use one form or another of a “pairs” trading strategy. There has been quite a bit of research into the subject, and even an article in a previous issue of S&C. Let’s start with the basic premise: Many stocks within the same or similar sectors tend to “track” one another — that is, they show correlated historical pricing. Let’s take an example that we traded a year or so ago, Merck (MRK) and Lilly (LLY). Both are pharmaceutical stocks, and both are highly capitalized Standard & Poor’s 500 index stocks....continuded