Pairs trade

[1] Pair trading was pioneered by Gerry Bamberger and later led by Nunzio Tartaglia's quantitative group at Morgan Stanley in the 1980s.

[3] The divergence within a pair can be caused by temporary supply/demand changes, large buy/sell orders for one security, reaction for important news about one of the companies, and so on.

Pairs trading strategy demands good position sizing, market timing, and decision making skill.

[11] Comprehensive empirical studies on pairs trading have investigated its profitability over the long-term in the US market using the distance method, co-integration, and copulas.

They have found that the distance and co-integration methods result in significant alphas and similar performance, but their profits have decreased over time.

Dealing with such adverse situations requires strict risk management rules, which have the trader exit an unprofitable trade as soon as the original setup—a bet for reversion to the mean—has been invalidated.

Some other risks include: Pepsi (PEP) and Coca-Cola (KO) are different companies that create a similar product, soda pop.