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Author: Larry Potter
Article source: http://www.vt.org/. Used with author's permission.
Quite a few firms are getting involved with "pairs trading" and we thought
we just might take a moment to explain what the term means.
Pairs trading means that you simultaneously go long one stock in a sector
and you go short another one. On the surface, you might be thinking, "why
would anyone do that?" Well, for a couple reasons.
First, in just about every sector there are a couple leaders and everyone
else is a laggard. For instance, in the tech area, IBM consistently
outperforms others in general. In the financial sector, GS can rack up points
better than most. So, leaning long the leaders when the time is right
often pays you generously.
Likewise, some companies often produce more good news than others. Some of
it is "manufactured" and some of it is real, but the street tends to pay
attention to the news generators and they often press them higher. So, if
you go long a stock putting out good news, while simultaneously shorting
their competition, you will often see something like this happen:
The stock putting out the good news pulls the sector higher. But, in a day
or two, the others in the sector often start falling back, while the news
generator holds up, or even keeps rising. If you are long the news stock,
and short the weakest competitor in the sector, chances are good that both
will be winning plays.
This isn't a new concept, but one that lost favor in the 90's, as everyone
simply went long. Now the idea of pairs trading is catching on again, and
it's worth your doing some homework on it if it sounds intriguing to you. For more FREE trading tips, enter your email address at:
http://lb.bcentral.com/ex/manage/subscriberprefs?customerid=12826
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