An introduction to long short hedging strategy.

At first appearance a long short strategy seems counter intuitive, surely the gains will offset the loss. However, it is a good way of reducing risk. The general idea is that you pick a winner in a sector and go long, and pick a loser and go short.

This way if there is a general movement in the market you are protected. If the market in general falls 20% your loss the long position will offset the gain on the the short position.

The overall profit is generated by the relative performance of the two assets. If the long asset goes up 10% and the sort asset only goes up 5%, you make an overall gain. Of course, if the relative performance goes against you you will still lose.

In summary the long short strategy is a good way of protecting against overall market movements so you can focus on the performance of the underlying assets.

Another way of using this strategy is to go long short based on time, either in futures or bond maturity. So when the curve deviates from the historic norm, you take a long short position to bet it will return to normal.