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Long and Short trading and investing strategies are often seen as advanced strategies only used for large hedge funds and large banks. However, retail traders can learn valuable lessons and ideas from this type of trading strategy that is usually reserved for institutional players.
What is a long-short strategy?
A long-short strategy as described by its name involves holding a basket of both long and short positions of assets all a part of a portfolio or a singular trading strategy. These assets tend to be equities securities or derivatives but can also be other asset classes such as commodities and FOREX. The idea behind the strategy is that due to the negative correlation between the shorts and long positions they cancel out much of the market volatility whilst at the same time profiting up movements in price in either direction.
Steps to develop a Long Short strategy
This step involves generating ideas for which asset classes you whish to trade. This may include FOREX, Commodities, Indices, or equities. For many traders, a combination of assets may produce an effective strategy. For example, someone may choose to allocate 60% of the portfolio to equities, 20% to FOREX and 20% to commodities or 100% to equities.
The aim of this section is to ensure that there are enough assets to be, diversified enough that a significant move in one direction will not blow the strategy out and to ensure. The strategy requires that enough assets are held to minimise the volatility. If too few assets are used, then the returns may not be consistent enough and prone to large gains and losses. A standard range may include 20 assets with the breakdown of long and short varying from strategy to strategy.
This step involves an element of discretion and is where the individual trader can utilise their own experiences and edge to enhance the strategy. For instance, some traders may choose to create a 50/50 split strategy. This means that exactly half the assets will be long, and half will be short. More specifically this split may occur via value weighting, number of assets or by price per share. Alternatively other strategies may involve having a lower proportion of short assets held, such as 20% Short and 80% long. These types of strategies may work better when in a trending market because the strategy can still make money on assets that are falling in value whilst also taking advantage of the strong overall market trend.
This is perhaps the most important step of the process. Choosing assets to hold can be a difficult task and may require both technical and fundamental analysis to find top performing assets to hold long and poor performing stocks to hold short. The craft of the long, short strategy is performed at this stage as a trader needs to find high performing or low performing assets.
An example of a 50/50 Long Short Portfolio construction is shown below. (NOTE this is a fictional Long Short portfolio and is not a real strategy or portfolio)
Positives of a Long Short Strategy
Disadvantages
Ultimately, a Long Short strategy for trading and investing can be a way to achieve more stability in volatile market conditions and provide a way to capitalise on market movements in both directions. Even just understanding how a Long-Short strategy works can provide traders and investors with enhanced understanding of how market forces impact on trading and potentially provide new strategies.
Disclaimer: Articles are from GO Markets analysts and contributors and are based on their independent analysis or personal experiences. Views, opinions or trading styles expressed are their own, and should not be taken as either representative of or shared by GO Markets. Advice, if any, is of a ‘general’ nature and not based on your personal objectives, financial situation or needs. Consider how appropriate the advice, if any, is to your objectives, financial situation and needs, before acting on the advice. If the advice relates to acquiring a particular financial product, you should obtain and consider the Product Disclosure Statement (PDS) and Financial Services Guide (FSG) for that product before making any decisions.
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