Pair trading is a form of market neutral investing were the risks that you take are based on the performance of one stock relative to another. The benefits of this type of trading technique is that the returns you receive are uncorrelated to the performance of the broader markets, which means that you can generate robust results in all types of market environments.
Hedge funds are very active pair traders, and whether they call their strategy long/short or statistical arbitrage, what they are doing is purchasing one stock and simultaneously selling short another stock. So, if you are interested in trading like a hedge fund, a pair trading strategy is one that is easy for you to employ.
If you are asking why does pair trading work, the answer is that the markets can be inefficient for small periods, providing a pair trading opportunity. Generally, companies within the same sector move in tandem with one another, but on occasion, the correlation can break down, giving you an opportunity to take advantage of this mispricing.
You can measure the relative value of one stock to another by the ratio which is stock A, divided by stock B. This ratio, generally trades in a tight range, but when the correlation between the two stocks breaks down, the ratio will move to the outer end of the historical distribution generating a signal that you can back-test using Pair Trade Finder.
By looking for public companies that are in the same business, you can back-test hundreds of pairs to determine which stock pairs you want to monitor. Your market neutral trading strategy will perform well in all market conditions as the impetus to take a position is not based on changes in the major stock indices.
Wishing you consistent profitability,