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Pair Trade

Trading Term

A Pair Trade is a market-neutral strategy that involves taking opposing positions in two correlated securities. Typically, an investor will go long on the undervalued security and short on the overvalued one, anticipating that the price relationship between the two will revert to its historical norm.

This strategy relies on the principle of mean reversion, where prices that have diverged from their historical correlation are expected to converge over time. By simultaneously buying and selling related securities, investors aim to profit from the relative movement between them, rather than from the overall market direction.

Example: Consider two companies in the same industry, such as Coca-Cola and Pepsi. If Coca-Cola’s stock price increases significantly while Pepsi’s remains stable, a trader might short Coca-Cola and go long on Pepsi, expecting the price gap to close.

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