Q8: What is Pairtrade?

A: Pairtrade is a market-neutral, relative-value trading strategy used systematically by professional trading houses over the past 20 years to profit from the stock market. In a pairtrade, you long a stock and at the same time short a certain number of shares of another stock, with the view that the stock you long is relatively stronger than the stock you short. If the market goes up strongly, you will make money from the long stock and lose money from the short stock. If the market crashes, you will make money from the short leg and lose money from the long leg. In this way you are hedged against sharp market movements in any direction.

A pairtrade tries to capture the relative value between two stocks. Imagine, for example, that the day before the Goldman Sachs IPO (Initial Public Offering), Merrill Lynch stock (MER) shoots up $6, while Lehman Brothers (LEH) is basically unchanged. Therefore, before that day's market close, you could long 800 shares of LEH and short 600 shares of MER, with the view that LEH may catch up, or MER may drop back, not caring whether the next day the market would go up or down, or whether Goldman's IPO would be successful.

For more details, please see the monograph, "Market Neutral Strategy," under the Tradetrek University heading.

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