Pepsi (PEP) and Coca Cola (KO) are different companies that create a similar product, soda pop. Historically, the two companies have shared similar dips and highs, depending on the soda pop market. If the price of Coca Cola were to go up a significant amount while Pepsi stayed the same, a pairs trader would buy Pepsi stock and sell Coca Cola stock, assuming that the two companies would later return to their historical balance point. If the price of Pepsi rose to close that gap in price, the trader would make money on the Pepsi stock, while if the price of Coca Cola fell, he would make money on having shorted the Coca Cola stock.
The motion of both shares (or the whole market) up or down does not affect the profit of the trader. His position is neutral - protected. Trader earns/lose only on the relative price change. The probability that the price ratio will come back to the long-term average is statistically proven.
Note: The performance charts and metrics shown here were generated by StockPairBuilder or based on StockPairBuilder data. These are the results of an ideal stock pair backtest based on freely available End-Of-Day prices.
Broker fees, execution price slippage, slippage of real price against EOD price, execution of false signals caused by price movement before EOD and others are NOT included in the results. Most of these influences that occur in real stock pair trading negatively affect the final performance of individual pairs and the strategy as a whole!
Always make sure you fully understand the issue of stock trading and especially the issue of stock pair trading before starting a real stock pair trading.
StockPairBuilder and StockPairTrader are only tools for backtesting and trading stock pairs. The user is always responsible for the execution of any business order.
To fully understand the trading of stock pairs, please visit stock pair trading course. The course is led by Petr Tmej, a trader with many years of experience in trading stock pairs and building portfolios.