Long/Short Strategy

The Long/Short investment strategy is used primarily by hedge funds, and involves taking both long and short positions.

A long position is one in which the trader wishes for the price of the stock to increase and therefore the trader will make money by selling the stock at more than he bought it for. On the other hand, a short position involves the trader ‘borrowing’ a stock, usually from a broker, and then selling it immediately. Money is made as if the price of the stock declines, the Trader buys the stock at the lower price and can then sell it as the price he originally sold it for, keeping the margin. In theory, you sell before you buy.

The Long/Short strategy comes into play as a method of reducing risk, or hedging your exposure to risk. (Note the term ‘hedging your bets’). The notion is you go long on one position and short on another, usually with a slight leaning one way or the other. What this does is reduces your risk, sure it reduces the reward that could be make if the trade is successful however as an investor we should be risk adverse and look to avoid leaving ourself open to potentially large losses.

A common strategy within Long/Short would be to be long bias, with the strategy being called ‘130/30’, which gives 130% exposure to long positions and 30% exposure to short positions. This type of investment is favoured by hedge funds as they can still generate profit even in a bearish market.

Example

The following videos, compiled by The Khan Academy, give a detailed explanation of the Long/Short Strategy as well as what happens if the market fluctuates either up or down.

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