surprised that nobody has yet explained pair-trading properly..
well, u basically eliminate market specific or systematic risks, and bet on narrowing or widening of price differential between a pair of stocks..(also called beta neutral strategy)
For example, last year, with the kind of corporate ethics anil ambani has and with all the problems, u expected adag stocks to go down. So you could have shorted it. But what if the market started going up? You could have lost money then...
any other way to make money even if the market went up? well, here pair-trading strategy comes. u could have gone long on Mukesh, and short on Anil.. and whether market went down or up, adag wud have under-performed mukesh's stocks.. of course, u wud have to use proper hedge ratio, beta analysis etc..and this strategy gave good returns in the last year.
this example is a bit crude, but the principle remains. u eliminate the market-risk and bet of price deferential to narrow or widen..