The subject of pair trades was raised on the "typical days trading the US" thread. Here are some links as an initial starting point. There will of course be many others.
http://www.tradetrek.com/education/pairtrade/market_neural_strategy04.asp
http://www.newbridgesecurities.com/reports/marketneutral_1-25-02.pdf
http://www.pairtrader.com/products.html
http://www.pairstrading.com/content.asp
http://www.tricom.com.au/equities/articles/pairs.asp
The following explanation of the concept has been lifted verbatim from the Tradetek site.
What is a market neutral trading strategy?
Under most circumstances one cannot be sure about the direction of the market (e.g., Dow Jones, NASDAQ, S&P 500 index, etc.), especially in the short term. A "market neutral trade" is a trade that does not get affected by the movement of the market as a whole: it is a trade that does not lose (or make) money simply because the overall market moves up or down. Through research on individual companies, you can gain views about the strengths and weaknesses of individual stocks. With this knowledge, you can implement "market neutral trading strategies" by buying stronger stocks and selling short weaker stocks. If you buy a certain number of shares of a stock and, at the same time, sell an appropriately chosen number of shares of another related stock, you can create a "market neutral" position that is hedged (i.e., immune) against uncertain market movements. If the market as a whole goes down a lot, you will most likely lose money from the stock you bought but make money from the stock you sold; if the market as a whole goes up a lot, you will most likely make money from the stock you bought but lose money from the stock you sold. The idea is that if you choose the stocks and the numbers of shares (that you buy and sell) appropriately, the gains and the losses due to the movements of the market overall offset each other.
What is a Pairtrade?
A Pairtrade is a special case of a market neutral trade. In a Pairtrade, you buy (go long) a stock, and, at the same time, you sell (go short) another stock, believing that the stock you go long is relatively stronger than the stock you go short. If the market goes up, you make money from the long stock and lose money from the short stock. If the market goes down, the opposite occurs: you make money from the short stock and lose money from the long stock. In either case, you are hedged against sharp market movements (up or down). A Pairtrade tries to capture the relative value between two stocks: in a down market, you expect the stock that you buy to drop less than the stock that you sell; in an up market, you expect the stock that you buy to move up more than the stock you sell. In either case, if the analysis of the individual stocks is correct, the trade results in a net profit without exposing you to the risk of overall market movement.
http://www.tradetrek.com/education/pairtrade/market_neural_strategy04.asp
http://www.newbridgesecurities.com/reports/marketneutral_1-25-02.pdf
http://www.pairtrader.com/products.html
http://www.pairstrading.com/content.asp
http://www.tricom.com.au/equities/articles/pairs.asp
The following explanation of the concept has been lifted verbatim from the Tradetek site.
What is a market neutral trading strategy?
Under most circumstances one cannot be sure about the direction of the market (e.g., Dow Jones, NASDAQ, S&P 500 index, etc.), especially in the short term. A "market neutral trade" is a trade that does not get affected by the movement of the market as a whole: it is a trade that does not lose (or make) money simply because the overall market moves up or down. Through research on individual companies, you can gain views about the strengths and weaknesses of individual stocks. With this knowledge, you can implement "market neutral trading strategies" by buying stronger stocks and selling short weaker stocks. If you buy a certain number of shares of a stock and, at the same time, sell an appropriately chosen number of shares of another related stock, you can create a "market neutral" position that is hedged (i.e., immune) against uncertain market movements. If the market as a whole goes down a lot, you will most likely lose money from the stock you bought but make money from the stock you sold; if the market as a whole goes up a lot, you will most likely make money from the stock you bought but lose money from the stock you sold. The idea is that if you choose the stocks and the numbers of shares (that you buy and sell) appropriately, the gains and the losses due to the movements of the market overall offset each other.
What is a Pairtrade?
A Pairtrade is a special case of a market neutral trade. In a Pairtrade, you buy (go long) a stock, and, at the same time, you sell (go short) another stock, believing that the stock you go long is relatively stronger than the stock you go short. If the market goes up, you make money from the long stock and lose money from the short stock. If the market goes down, the opposite occurs: you make money from the short stock and lose money from the long stock. In either case, you are hedged against sharp market movements (up or down). A Pairtrade tries to capture the relative value between two stocks: in a down market, you expect the stock that you buy to drop less than the stock that you sell; in an up market, you expect the stock that you buy to move up more than the stock you sell. In either case, if the analysis of the individual stocks is correct, the trade results in a net profit without exposing you to the risk of overall market movement.
