Finance and capital markets
Seeing how the long-short portfolio might do in different market conditions (assuming that the underlying thesis is right). Created by Sal Khan.
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- Is the key to this strategy investing equal dollar amounts in each stock? (in this case buying $10 worth of stock in each co.)(3 votes)
- If you want to hedge the risk of the market going up or down, you need your long and short position to balance out indeed (but don't forget that you are buying one type of share and shorting the other). Of course, this strategy is only going to work if your predictions were right.(5 votes)
- Is it a good assumption at0:47that if market goes up, share price of companies A & B will also necessarily go up? Or, at2:26that if market goes down, share price of both will necessarily go down?(4 votes)
- Would companies A and B typically be in the same industry, or is it also common to place a long short between two entirely different companies?(3 votes)
- This questions is extremely simple... How can you "short" or sell a stock which you do not own? Is taking a short position on a stock sort of like you claiming that stock with the expectation that it will not be successful?(1 vote)
- Does a scenario exist where both companies exceed my expectations?(1 vote)
- No. You were comparing the companies to each other. You believed that company B will do better than company A. So, either company B outperforms company A, or company A outperforms company B. It can't be both.(2 votes)
- when you buy and sell stocks you always find a buyer and a seller? or you need to wait for offers?(1 vote)
- This is what a stock exchange is for. It brings buyers and sellers together. If you want to buy or sell, you give an order to a stock broker, and the stock broker executes it for you at the exchange, at the market price.(1 vote)
- Is there a legal connection to long-short stocks? I mean, if you sell one kind of stock and buy another is that automatically long-shorting them? Or is this a particular kind of hedge fund that creates a connection between the two? I'm missing a key connection point here.(1 vote)
- Long-short just means that you are doing both buying and short-selling. The result of this is that your exposure to aggregate moves in the stock market should be lower than it would be if you only were selling. You can in principle get to 0 market exposure by shorting exactly as much as you buy. If you do that then (in principle) all of your investment return will come from the outperformance of your longs relative to your shorts.(1 vote)
- Why this long short strategy called hedge fund strategy? is this strategy exclusively used by hedge fund only?(1 vote)
- Hedge funds are called hedge funds because they generally involve a group of people trying to hedge money out of the market and into their control? Or are they called hedge funds because you are trying to hedge out the market risk? Even if all you did was short sell, wouldn't that still be a hedge fund?(1 vote)
- There really is no meaning anymore to the word "hedge" in hedge fund. Way, way back the first hedge funds were called that because they were supposed to hedge out most or all of the market risk. Some hedge funds do that today, but the name has broadened so much that it now includes basically any private fund that charges performance fees.(0 votes)
In my attempt to have a portfolio whose performance should depend only on my ability to identify good companies, and to identify bad companies, and not be held sway by whatever the market might do, I have bought a share of company B, thinking that it's a pretty good company and will do better than expected. And I have shorted two shares of company A. And I've shorted two of them, because they're only at $5 a share, and I wanted to short the same dollar amount. So now I want to think about, assuming that I was right, that company B will do better than company A relative to each other, how my investment will do if the stock market moves up, or if the stock market moves down. So let's imagine a situation where the stock market moves up. In that situation, you could imagine both of these stocks will go up. So let's say company B goes up in percentage terms more than company A. So let's say that company B gets to $15. So it gets to $15 a share. So it is up 50%. And let's say that company A only goes up by 20%, so it goes to $6 a share. So in that situation, what happened? I clearly make a lot of money on company B, on my long position, when the stock market goes up. $10 became $15. So I made $5 there. And I clearly lost money on my short position, because I sold it at $5, and now I'm going to have to buy it back at $6 if I want to cover my short position. So this $10 position-- remember, I have two shares of them-- are now worth $12, 2 times $6. And since this is a short position, I will lose $2. But because the company that I thought would do better did do better, it went up by 50%, while this only went up by 20% percent, I still make money. I still make a $3 profit. Now let's think about what happens if the whole stock market goes down. And I'm going to assume that I'm good at picking the right companies. So I'm going to assume that my thesis holds, that B does better relative to A. So let's say in this negative scenario, B goes down by 20%. So it gets to $8 a share. So this is the market up, this is the market up scenario. Now let's imagine the market down scenario. So now my position in B goes from $10 $8. So I lose $2 on my long position. But when the market went down, I was right, A is not that great of a company. So it goes down more. Let's imagine that it goes down by 50%. So A goes down by 50% all the way to $2.50 per share. So my position in A, the short position that was $10, it is now a $5 short position, two shares at $2.50 per share. So this is a short position. I sold the stock, I borrowed and sold it $10. Now I can buy it back at $5. I make $5 on the short position when the market goes down. So even though I lost some money on my long position when the market goes down, I more than make up for it on my short position. So even in the down market, assuming my stock picking is good, I have still made $3. And so what we've set up here is a long short hedge. And what's cool about it is, it's only dependent on the investor's ability to differentiate between companies that are more or less likely to do well relative to other companies. And it's not as dependent on someone's ability to pick which direction the market itself will be going. And so when people talk about long-short hedge funds, they're talking about hedge funds are essentially doing this. They're trying to hedge out the market risk.