What is Long-Short Equity?
What is Long-Short Equity?
How AI can help you invest
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Long vs. Short Investing Strategies
When an investor buys into a position they are said to be going long. The long position meaning is simple, they are bullish on a particular stock, industry, or sector. Conversely, when an individual is bearish on a stock or sector, this is where the short position meaning comes in. "Short" simply means they are more bearish on the market.
When referring to the stock market it is usually long position vs short position as some traders are bullish and some are bearish. Long and short trading pits buyers and sellers against one another in an eternal battle to find out who will triumph and send prices higher… or lower.
If the bulls win, the market goes higher. On the other hand, if the bears win and sentiment in the market or a stock goes south, look out below. If the last few years have taught us anything it's that the market can be pretty volatile, especially with the wave of options traders, as well as features like 24-hour investing.
Large swings higher or lower can seemingly come out of nowhere and at a moment's notice. Sometimes the bulls are victorious, other times it's the bears that come out on top and all it takes to really get the ball rolling sometimes is a little push.
Like the most recent market rally. October of 2022, the S&P 500 was in the dumps, at its lowest point since the pandemic. With fears of a recession rising, many in the market thought the market would only sink lower.
Year-to-date (YTD), the S&P 500 has been on a near 20% tear, making it hard for some to not increase the size of those long positions.
However, there are ETFs and mutual funds out there that employ a singular strategy that entails a long short position simultaneously. These long short funds are just as they sound.
They are funds that employ a strategy that utilizes long (bullish) positions and short (bearish) positions at the same time. Let's dive in a little deeper to better understand what a long-short equity strategy is and how you can use it in your own investing.
What is Long-Short?
A long-short equity strategy is an investing strategy that takes bullish positions, in the form of equity (shares) or options contracts, that are expected to appreciate, while also at the same time taking short positions in stocks that are expected to decline in price (1). The goal of this kind of strategy is to minimize market exposure while profiting from stock gains in the long positions, along with price declines in the short positions. While this method of investing can come with its own set of risks and drawbacks, the strategy is usually expected to be profitable on a net basis.
The long-short equity strategy is popular with options traders, hedge funds, and institutional investors, many of which employ a market-neutral strategy, in which dollar amounts of both long and short positions are equal.
This investment strategy can be tricky, however. Short opportunities are said to be a bit more difficult to find than that of an opportune long position, see this current market rally for reasons as to why. When the market is moving up and to the right, finding stocks that aren’t going to be taking part in the rally can seem difficult.
Hedge funds and other financial institutions have solved for these market conditions. Simply by skewing the allocation toward one side of the coin as opposed to the other, long vs. short, they can take better advantage of moves like the one we are seeing at the time of this writing.
A common long-short strategy hedge fund and institutional investors will use is the 130/30 strategy. This means the long short fund uses a ratio of 130% of starting capital allocated to long positions and accomplishes this by taking in 30% of the starting capital from shorting stocks.
You might be thinking to yourself, “why not just pick one or the other?,” we’ll address the “why” behind this investment strategy next.
Why Use a Long-Short Strategy?
The entire point of a long-short strategy is to profit from stocks, industries, or sectors regardless of if they’re moving in different directions. Since not all stocks and sectors will all rise in the same proportion or at the same time, this strategy allows funds to play both sides of the coin.
Similarly, the everyday investor can also utilize this same strategy to add a little more downside protection to their portfolio (2). The idea here would be to take full advantage of the market rising higher, as it has been for weeks up to the point of this writing, while at the same time having a smaller position that is providing you some protection should the market pull back or reverse course completely.
This strategy isn’t foolproof and takes some good foundational knowledge, as well as being a more “hands-on” approach. However, you don’t need to shoulder this responsibility on your own.
There are ETFs and mutual funds that afford investors the ability to offshore the monitoring of such positions. Long-short equity ETFs and mutual funds are managed by the pros, so you won’t have to worry too much about how to tweak this strategy or how to effectively run it either (3). You leave all that to the pros, while you go on about your life.
Once you determine this is the right strategy for you, you can then find a long list of funds available for you to take advantage of this strategy and Magnifi can help you with that. Now, finding which long-short funds to invest in has never been easier. Let’s check out some of the ways Magnifi helps you personalize your investment portfolio.
How Magnifi Can Help You Invest in Long-Short Equities
With an AI investing app like Magnifi, investing in these alternative investment strategies is easier than ever before. Not every investing app has the ability to plug users into many mutual funds like those that commonly employ the long-short strategy. Now, the sensible investor can take on the sophisticated strategies that have allowed hedge funds and other institutional investors to make money in the market both ways.
Check out your top three long-short funds below to get started.
If this is a strategy you’re looking to gain some exposure to, you can also run a search for long-short funds in the Discover section. Take a look at some of the common searches run by Magnifi users to find these funds:
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References:
- “A Guide to Long-Short Equity Investing,” February 9, 2023, smartasset.com, https://smartasset.com/financial-advisor/long-short-equity
- “Downside Protection,” February 2, 2023, magnifi.com, https://magnifi.com/learn/downside-protection
- “Guide to investing in long/short funds,” blackrock.com, https://www.blackrock.com/us/individual/products/long-short-funds
Disclosures:
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The information and data are as of July 20, 2023 unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
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