Pairs trading

Buying one security and shorting a closely related one when their prices stray from their usual relationship, expecting it to return. Market exposure largely cancels; the risk is that the relationship has changed.

Where you will meet it

Pairs trading appears in 2 learning outcomes on the CFA syllabus. A few of them:

• Discuss equity-related hedge fund strategies: their investment features, how they are put into practice and the role they play in a portfolio
  CFA Level II · Alternative Investments

  “Equity market neutral managers balance longs and shorts to hold beta, and often sector exposure, near zero, using pairs trading or statistical models with leverage to magnify small spreads, so their returns are low-volatility and bond-like.”

• Explain active approaches that exploit statistical arbitrage and the workings of market microstructure
  CFA Level III · Portfolio Management Pathway

  “The standard example is pairs trading: two historically co-moving stocks are identified, and when their price spread widens abnormally the manager buys the cheap one and shorts the rich one, closing when the spread returns to normal.”

Practise it

• Today's practice question One question, with every wrong option explained.
• Free Level I diagnostic test Twelve questions that show which topics to start with.
• Free finance calculators Check your arithmetic on the exam's core formulas.

All terms beginning with P · Glossary