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What is pair trading?
The idea
Pair trading combines buying one asset with selling another short. The mean-reversion approach looks for an unusual gap between related assets and tests the idea that the gap will narrow.
- ObserveA has lagged behind B.
- Pair the positionsBuy A · sell B short.
- Follow the relationshipThe gap may narrow or widen.
Buying A creates the long position. Selling B short means selling borrowed shares, then buying them back later. The result comes from both positions together.
How a pair trade makes or loses money
Assume the trader expects A to catch up relative to B. Both positions start at $1,000. Select a scenario to see how each leg contributes.
Fictional examples, before fees, borrowing charges, financing and dividends owed on the short leg. Gross exposure is $2,000; this is not the cash committed or the margin requirement.
Must the market go up?
No. With the same starting positions, A outperforming B by three percentage points produces $30 before costs in either of these fictional scenarios.
B −$10+$30
Before costs · same starting positions
B +$40+$30
Before costs · same starting positions
Market neutrality is an objective. Equal dollar amounts do not remove differences in market sensitivity, sector exposure or changing relationships.
Three terms you will meet
The relationship you measure
For a simple price-difference model: A = $100, B = $50 and β = 2 gives a spread of $0. PairScanner uses log prices; its β is not a share count.
Does the relationship hold?
A cointegration test looks for evidence of a stable combination of price series over the period tested. This sketch illustrates the idea; it is not a statistical test result.
How unusual is the spread?
Example: Z = −2
If the mean is 0, the standard deviation is 1 and the spread is −2, then Z = −2. That means two standard deviations below the mean, not a probability of profit.
What can go wrong?
An unusual gap does not have to close. The relationship can change, and a pattern found in historical data can also be a coincidence.
Relationship breaks
A takeover or a change in business can create a new equilibrium.
Borrowing and costs
Borrow fees, dividends and recalls can change the trade.
Uneven execution
One filled leg leaves exposure until the other fills.
Losses on an individual short position can be unlimited in theory. Margin calls and forced exits are possible; a stop order does not guarantee an execution price.
How to explore without placing a trade
Read an example
Inspect the charts and their dates.
Check the relationship
Compare tests, context and limits.
Build a watchlist
Follow a hypothesis before placing orders.
Read a dated analysis first. These public studies show different conclusions, including a failed cointegration test, and are available without an account.
Discover pairs beyond the names you know
You do not need to know which companies to pair. PairScanner’s algorithm finds candidates within its supported universe and performs the statistical calculations automatically. Open the scanner: the pair analyses are already there.
| What you get | Professional software | Other retail software | PairScannerReady-to-use pair analysis |
|---|---|---|---|
| Access | SubscriptionLicence and data costs depend on the offer | Free + paidFeatures depend on the plan | $0Sign up with just your email |
| Finding pairs | Market screening and quantitative research tools. | Screeners, charts and indicators, depending on the software. | Pairs discovered automatically. Including companies you have never searched for. |
| Calculations | Advanced analytics and customizable models. | Built-in indicators and analysis tools; pair features vary. | The algorithm does the calculations automatically: cointegration, hedge ratio, spread and Z-score. |
| Historical depth | Historical datasets, with coverage depending on the licence. | History varies by market, data provider and plan. | Five years of daily data for pair analysis, subject to available common history. |
| Getting results | Research workflows and automation options. | Scans, scripts and alerts, depending on the software. | Results calculated daily. No code to write, no pair to enter manually. |
| Your workflow | Broad market research and analysis tools. | Charting, technical analysis or specialized tools. | Pair scanner, analysis and monitoring in one place. Watchlists and Z-score email alerts included. |
PairScanner: no card required. Creating a free account does not start a paid subscription or authorize automatic charges.
General overview: features vary by software and plan. PairScanner is an analysis tool; orders stay with your broker.
Further reading: Fidelity · Pairs trading.
Educational content. Historical relationships can break. Trading and short selling involve a risk of loss.
Continue with the practical guide