Market consolidation? Pair trading offers a path to profit

While India's growth story remains intact, market returns may moderate in the near term after two years of outperformance.

After a sharp correction from the record highs of September, the equity market is widely anticipated to swing within a range as it wavers through moderating earnings growth, consumption slowdown, lofty valuations, and other global macroeconomic headwinds. Even though a persistent sideways movement of the market is likely to drag overall returns, traders are shifting towards pair trading to beat the market.

Pair trading is a market-neutral strategy that allows investors to capitalise on the relative performance of two stocks by bundling long and short positions while reducing exposure to overall market fluctuations. Using this strategy allows traders to bypass the overall muted market by using the relative performances of two correlated stocks for cashing out profits.

Here are some short-term pair trade ideas within sectors that can help investors make the most out of the sideways market movement.

JSW Steel vs Tata Steel

The two steelmakers often move in tandem, largely affected by the same triggers. Despite that, while JSW Steel has gained over 1 percent in the past three months, Tata Steel has slipped more than 6 percent, creating a big price gap between the two. On that account, a pair trade can be executed between the two, where investors can go long on Tata Steel in anticipation of the stock catching up, while going short on JSW Steel in hopes of a correction in the counter.

ICICI Bank vs Axis Bank

Banking peers ICICI Bank and Axis Bank make up a good duo for pair trades due to their similar business operations and higher dependence on loan growth compared to other rivals. A look at their price action, however, shows that while ICICI Bank has risen over 5 percent during the last three months, Axis Bank has fallen more than 3 percent, creating a gap of 8 percent. Investors can use this gap to go long on Axis Bank while building short positions in ICICI Bank as there exists a strong possibility of this price gap narrowing in the coming months, either through Axis Bank's outperformance or ICICI Bank's correction.

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GAIL vs Indraprastha Gas

Operating in the same city gas distribution business, GAIL and Indraprastha Gas also make up for a good trade pair, as highlighted by Incred Equities. Though both the stocks have gone through a correction in the past three months, shares of Indraprastha Gas have witnessed a steeper fall of 41 percent compared to GAIL's 17 percent decline. This price differential leaves room for shares of IGL to either normalise at higher levels or GAIL to correct further.

Bajaj Finance vs Cholamandalam Finance

Bajaj Finance and Cholamandalam Finance is another set of pair trades pointed out by Incred Equities. Shares of Bajaj Finance have fallen a little over 4 percent in the past three months, while those of Cholamandalam are down around 13 percent, giving way to a wide gap in between. Given that the two stocks have historically traded in tandem, investors can choose to go long on Cholamandalam and short on Bajaj Finance in hopes of the price gap narrowing in the short-term.

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