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Current time:0:00Total duration:3:35

Video transcript

let's say I've been researching some stocks to potentially invest in and I feel pretty good at my ability to predict how good company is going to do relative to people's expectations or the markets expectations and in particular I focus on companies a and B and in the case of Company A I think it's going to do a lot worse than the market expects it to do so I'm tempted I'm tempted to short it and in the case of Company B I think it's going to do much better than the market expects so I'm tempted to buy it or go long but there's one thing about this process it gets me a little bit uncomfortable I have confidence in my ability to to pick out companies that are going to outperform the market are going to underperform the market but I have no confidence in my ability to predict the market so in general you know let me draw a little chart of the market this is the market price maybe this is the S&P 500 or the Nasdaq and I've just found that it's pretty as good as random as opposed to me trying to pick out bottoms of the markets or tops of the markets and all of the rest and so my fear is what happens if I buy Company B based on my sound research and then the market goes down then Company B will probably still go down maybe it won't go down as much as the market but it'll still go down and I'll lose money or what if i short company a and the market goes up maybe it won't go maybe company won't go a won't go up as much as the market but I'll still lose money on my short position which is essentially a a bet that the stock is going to go down so how can I is there some arrangement I can do some combination of buying Company B and selling company or shorting company a that will essentially hedge out a lot of this market risk and as you can imagine there is and I won't go into all of the statistics of it in beta and how you can really try to statistically hedge out the market risk but the general idea is if you really think this is going to outperform the market or definitely outperform Company A and if you think a is going to underperform the market or definitely underperform relative to Company B you can go you can buy a similar amount of B as you will short Company A so in this case let's just do one share you can obviously do multiples of this you buy one let me write it over here so we can look at so you buy one share of Company B one share and you sell or you short one share of company a you borrow the share you sell it you'll have to buy it in a future date so you short you short that shouldn't say one shared you short two shares you short two shares of Company A and the reason why I'm saying two shares of company instead of one share is because a is only five dollars per share and B is ten dollars per share so I want to do roughly the same amount and once again you can do fancier statistics on it to tweak it so you can see how much they actually move with the market but we're not going to worry about that right here so for simplicity for simplicity what we've done here is we've taken a long position let me write it over here we've taken a long position long position in B and we have a ten dollar long position and we've taken a short position short position in a and it is also a ten dollar short position once again because a is five dollars per share so we took two shares of a it makes the same dollar amount now let's think about and maybe I'll save this for the next video I want you to think about what happens if the market moves up or down but B outperforms a or a outperforms B