This article originally appeared on Traders Reserve.
They say the best things come in pairs, and while there are a variety of strategies traders can use to take advantage of this volatile market, one of the best is what’s known as pair trades.
The latest bout of market volatility has left many traders scratching their heads and wondering which way the market is headed next. One day we see the Dow surge 200 points on strong jobs report expectations, the next day stocks plummet on surging oil prices and an intensification of violence in Libya. The swings are enough to paralyze most traders; however, this kind of volatility doesn’t have to stifle your trading.
What is Pair Trading?
Basically, a pair trade is a strategy of matching up one long position in a stock with a short position in another. The key here is to be long a stock you suspect will outperform the market even while the general market is suffering from extreme volatility. The second component here is to be short a stock that is likely to underperform the market during periods of wild flux.
Although there are many variations on the pair trade theme, one style of trading is to be long a stock and short a stock that come from the same sector. This strategy of pair trading essentially involves picking a leading stock in a specific sector and going long, while also shorting the laggard stocks in the same space.
Let’s take a look at three pair trades that do just that.
Long Dell, Short HP
In the personal computer space, there’s been a distinct divergence of late between rivals Dell Inc. (NASDAQ: DELL) and Hewlett-Packard (NYSE: HPQ). Last month, Dell announced earnings that crushed Wall Street expectations, and the recent upbeat numbers have been recognized by traders. DELL shares are up nearly 15% over the past three months. By comparison, HP shares are up just a sliver (0.4%) in the past three months. Though the HP did best earnings expectations in its most recent quarter, its rather lackluster profit forecast gave traders a reason to sell.
This pair trade is long DELL and short HPQ.