Pairs Trading: A Market Neutral Strategy to Mitigate Market Risk

Pairs trading is a market neutral strategy that involves going long on two or three stocks while going short on two or three other stocks. By selecting undervalued and overvalued companies, this strategy seeks to mitigate market risk and focus on individual companies. It allows investors to bet on specific companies rather than taking a market bet. This approach is commonly used by hedge funds, with a typical allocation of 60% long and 40% short positions. By taking both long and short positions, hedge funds aim to minimize the impact of market dynamics on their overall performance. This strategy is particularly suitable for investors who have insights into undervalued or overvalued companies and want to reduce their exposure to market risk while still participating in equity markets.