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Trading Strategies

What Is Pairs Trading

Pairs trading holds one trade bought and one sold on two things that move together, so that the market's direction cancels and only the gap between the two is traded. This paper shows you the Nasdaq divided by the Dow through every trading day of 2025 from real closes, the idea as two boats on one rope moved by the same tide, the two indices on one scale on the daily chart, the two legs between the ratio's low in April and its high in November, and how a pair is read across two windows on your platform.

Difficulty
Beginner
Reading time
5 min
Pages
8
Reviewed by
Saman Rahbar

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Two markets as one line

Pairs trading is one trade bought and one sold, on two things that move together. Here are two such things as one line, from real daily closes: the Nasdaq index divided by the Dow, every trading day of 2025. The line is not a price. It moves only when the two indices move differently, and stands still when they rise or fall together. It was lowest on 4 April, at 0.454, when the Nasdaq was cheapest against the Dow, and highest on 3 November, at 0.549. With one index bought and the other sold, the market's direction cancels, and this line is what is left to trade.

Two boats on one rope

Picture two boats on one rope. The tide moves both boats together, up and down, and while it does the rope between them does not change; it changes only when one boat pulls ahead of the other. The two indices are the boats and the market is the tide. A pairs trader watches the rope, not the tide, because the tide is exactly what one trade bought and one trade sold cancel out, and the rope is what is left. The rope can lengthen for a long time, and the trader's whole question is what it will do.

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