Home Analysis Equity Strategies – The Long/short Equity Strategy

Equity Strategies – The Long/short Equity Strategy

by Danijel

EquityEquity strategies of most hedge funds rely on market-neutral strategy, which is a variation of the long/short equity strategy. The difference is that in the market-neutral strategy both short and long positions are about equal, with long equity positions’ risk being mitigated through short positions equity in the similar sectors and markets; on the other hand, long/short equity strategy requires clear emphasis on either long equity positions or short equity positions. The emphasis is usually on the long equity positions, although there are some hedge funds that focus on short equity positions instead.

Long/short equity is a type of investment strategy where an investor acquires long positions on equity whose value is expected to rise and selling short equities whose price is expected to drop. In terms of Forex markets, a long/short equity strategy is designed to limit the risks of the open market and acquire profits on price drops in short positions and price spikes in long positions. As long as either one of those positions is making more profit than the other, the strategy should work. The emphasis is on “should” as that is not always the case.

There are numerous problems when it comes to managing long/short equity funds. The risks to the portfolio have to be identified, specified and assessed accordingly, which is no easy task: as the number of factors on the open markets constantly increases, risk hedging is becoming progressively harder and less reliable. Not to mention the fact that market conditions have the habit of changing suddenly and unexpectedly. There is also the need to actively manage short positions, especially if they are not successful. Since they are much harder to sell effectively, short positions tend to accumulate in a portfolio, weighing it down with needless and excessive (seemingly limitless) costs.

Long/short equity managers typically rely on fundamental analysis and discretionary trading (and possibly technical analysis) to pick out which investment products will rise and which will fall, usually due to being miss-priced. Once trading opportunities are identified, the currency pairs are further analyzed, along with their financial history and background, especially if the market is deemed as underdeveloped or considered unsafe. Once investment products are selected, their positions are sized and trades are executed. One thing the manager needs to be mindful of is the long/short ratio – namely to make sure that there are no more short positions than required, and that exposure is under control, within the well-established limits.

In order to accomplish that, managers need strong short selling skills. In today’s markets, there is a constant stream of buyouts, news announcements, corporate events, regulatory changes etc. Every single one of them is a potential opportunity to be capitalized on. Despite popular views, short selling is nothing like executing long orders; for one, there is a great number of things that can go wrong: the losses are theoretically limitless, while some sold positions may turn profitable after all. All these and many other factors make a manager with high short selling skills worth their weight in gold.

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