Unlike The Fly, some of us are not satisfied with “resting on our laurels” and drinking rich man’s whiskey for the remainder of the calendar year—mostly because we are not up an ungodly 35% YTD.

Here’s a strategy that can work in this environment: pairs trading.

For those uninitiated, pairs trading allows you to play both sides of the market. When you do this, consider yourself kind of like a hedge fund manager, only much, much poorer.

Basically, you buy one stock in a particular sector, and then short another stock within the same sector. You can also think of this as a market neutral-like strategy. The goal is to bank coin on both sides, viz., have the long position go up and the short position fall lower in price.

However, unlike a purely long or a purely short position, a profit can be made as well, by the spread working in your favor. That is to say, if the long position outperforms the short or verse vicesa [sic]. The trade can be “successful” even if both rise, or both fall, or if one rises or falls faster than the other.

The key is to do accurate relative strength analysis because profits depend on your ability to take advantage of the divergences between two stocks within the same sector. Think of it as a “hedged” trade where the strategy is to take advantage of a technically strong stock and a technically weak stock.

The reason I bring this to your attention (aside from being a generous and merciful individual) is that this strategy can be useful in this type of market that produces wide swings, with many names going lower, but others merely pulling back with the market to support levels, or vice versa.

My basic rules to structure this trade are:

Long:

1.) The stock must have at least three positive technical attributes, one of which must be RS. You pick the others that you use most often or feel most comfortable with. I happen to simply use moving averages and supply/demand from a P&F chart.

2.) The stock must be in an overall uptrend and above a bullish support line.

3.) Emphasize stocks that have strong RS to the market and peer group.

Short:

 1.) The stock should have less than 3 positive technical attributes. Zero is obviously best.  

2.) The stock is in an overall negative trend and the price is below a bearish resistance line.

3.) Emphasis on stocks that have weak RS to the market and peer group.

That said, here is one pair trade in the retail sector:

Long TJX:

Short AEO:

Compare the two relative to the Consumer Discretionary ETF, XLY:

Now that you have an idea of a “pair trade”, play around, do some research and go out and be profitable.

Disclaimer: Profits are not guaranteed by FDIC, MBIA,  AMBAC or any other insurance company. Not that it really matters if they were, anyway.