Equity long short

Equity long shorts represent a trading strategy, that is very popular among hedge funds. The strategy is composed of more steps. At first, an investor must identify his investment universe, from which he will pick the assets to his portfolio. Once the investor has established his universe, the assets are ranked from lowest to highest according to a particular variable. This variable usually offers a prediction of the future assets returns based on past performance. This variable could be based on many market effects such as momentum, reversal, volatility, or it could also be based on some other alternative data.

The strategy itself then consists of buying assets, that are undervalued or should earn a higher return according to our variable, with shorting an overvalued assets that are expected to underperform. At best scenario, the price of assets in long position will increase, and the value of assets in short positions will decline. This scenario would bring profits from both sides.

The upside of this strategy is that it would work even if the short position gains on value, but only in a case where the long position returns edge the ones from a short position. To consider this as true in every case, there is a second condition that has to be met. The condition is that the investor has to hold equal value of long and short positions. This kind of distribution represents a market neutral strategy.

However, not all of the equity long-short strategies are market neutral. Many investors want to maintain their investments in a long market direction since the equity markets have a tendency to move up in the long term. In this case, they apply a different distribution of positions. For example, they can use the so-called “130/30” strategy with 130% exposure to long positions and 30% exposure to short positions.

All in all, the main goal of equity long-short strategy is to minimize the market exposure and earn profits from a change in the value difference between two asset groups.

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The Encyclopedia of Quantitative Trading Strategies

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