Trading Correlated Stocks/Commodities/Indices
Pair Trading is a trading strategy that involves trading correlated stocks, commodities, indices that moves in a similar manner. Which means that they chart look very similar. Both, should move in the same direction whatever way the market moves.
Buy (long) one, the underperdormer and sell (short) the other, the outperformer
This trading strategy behind this required to buy (long) one, the underperdormer and sell (short) the other, the outperformer.
Like this, the trader will hope that their long term historical relationship will be restore, and the chart once again will meet, re-starting again their similar way of moving. When the two chart meet again, that will be the moment to close both trade simultaneously, with the hope that losses if any, will be less than the gains. Whichever way it goes.
Be aware that you are increase your exposure
This trading strategy isn’t bullet proof like any other strategy, specially when using leverage products. Traders have to be aware that they will be increasing their exposure to the market. But it will also increase their chances of profit.
Usually this strategy is used with equities in the same sector, banks, miners and retailers are one of the most popular sectors. You could use ANZ and NAB or BHP and RIO or even Chevron and WPL (Woodside Petroleum).
One thing that traders should realize is that some securities diverge and converge more often than other. Also, that this is more of longer term strategy.
Source: Google Finance