Pairs trading is market-neutral: go long one stock and short a highly correlated one. You profit from the spread between them rather than market direction. It's a classic statistical arbitrage strategy.
Answer: Highly correlated historically. Pairs trading works by betting that two correlated stocks will revert to their historical relationship.
Answer: Gains and losses on the long/short legs offset market risk. Long one, short the other — overall market moves (beta) largely cancel out, isolating the relative performance.
Answer: Buy the underperformer and short the outperformer, betting on mean reversion. Pairs traders exploit divergences — when the spread is unusually wide, they bet it will revert to the historical mean.
Answer: Two stocks have a stable long-run equilibrium relationship despite short-term divergences. Cointegrated pairs may diverge short-term but are statistically pulled back toward each other — the core pairs trading premise.
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