To pair trade equities, I seek highly correlated stocks in the same sector. When I spot a deviation from the historical correlation, I might transact, seeking to profit on a correction of the deviation.
For instance, if Goldman Sachs (GS) and Bank of America (BAC) are trending over the same path over a period of time and I spot a deviation in one’s path, I might sell GS short, and buy BAC, seeking to capitalize on the fact that GS might be perceived as overvalued, and BAC might be perceived as undervalued. Thus, I am using both technical analysis and fundamental analysis in this strategy.
If GS decreases in price and BAC increases in price, I cash in my gains based on a pre-determined profit target, or cut my losses based on a pre-determined stop-loss threshold. I rarely “pair trade” on as an intra-day basis, my holding period is usually a few days.
I also might spot a trend with an exchange traded fund. For example, I might buy the Financial Select Sector Spider (XLF), and short Goldman Sachs, similar to the above mentioned scenario.