The Coca-Cola Company (KO), PepsiCo, Inc. (PEP) & More: Don’t Be Fooled By The Fancy Name — Statistical Arbitrage Is A Simple Way To Profit

Here’s another well-known pair trade: Wal-Mart Stores, Inc. (NYSE:WMT) and Target Corporation (NYSE:TGT).

As you can see, Target Corporation (NYSE:TGT) climbed out of the historical correlation range on the chart. Traders invested in the pair would short Target Corporation (NYSE:TGT), holding until the historical correlation came back into sync.

It’s important to remember that it’s not always obvious names that present enough correlation to pair-trade. One example of this is the relationship between Citigroup Inc (NYSE:C) and Harley-Davidson, Inc. (NYSE:HOG).

Other than trading on the same exchange, I cannot imagine why two companies that are so diverse would be correlated so closely. The reason could have something to do with the fact that consumers may borrow money to buy Harley-Davidson, Inc. (NYSE:HOG) motorcycles, but that’s only a guess.

Risks to Consider: Although closely correlated stock pairs generally come back into sync with each other after diverging, there is no rule that says this has to happen. Stock pairs can stay out of sync for a substantial period of time, depending on the underlying circumstances. Always use stops and position size properly.

Action to Take –> Begin to chart the common pairs like Coca Cola and PepsiCo, Inc. (NYSE:PEP), General Motors Company (NYSE:GM) and Ford Motor Company (NYSE:F), and other closely related companies. In addition, experiment with finding correlated pairs by simply charting a variety of pairs of stocks. Although I like to use daily charts, tradable correlations can be found in all timeframes. Professional traders often use software, rather than visual charts, to find historical pairs showing a statistical aberration from each other. Some trading platforms have this ability built in, but this type of software is readily available.

This article was originally written by David Goodboy and posted on StreetAuthority.