Common Hedge Fund Strategies
Hedge Funds use a variety of different strategies that serve as insurance to your trades. These strategies can be grouped into certain categories that guide an analyst or investor in determining a fund manager’s skill and assessing how a particular strategy might work under certain macroeconomic conditions.
While no particular strategy can be said to be the key to a hedge fund success, some broadly used strategies include:
1. Long/Short Strategy
This strategy requires maintaining of long and short positions while buying currencies that seem to be undervalued and selling ones that are overvalued. It is an extension of the pairs trading technique that calls for pledging long positions in winning currencies as collateral to finance short positions in the losing currencies. The long/short strategy lessens market risk since the shorts counterbalance the long market exposure.
2. Market Neutral Strategy
There are some hedge funds that minimize the potential risk involved further by having equal long and short positions. Market neutral strategy not only involves lower risk but also provides lower returns.
3. Strategies Based on Macro Economic Trends
4. Foreign Currency Options
This is also one of the popular trading strategies implemented by numerous hedge funds. This means you can buy or sell a currency at a scheduled date in the future but there is no obligation to be involved. It gives traders with some protection from short-term trades. Some commonly used strategies using the foreign currency options are the long-term straddle, long-term strangle, bull spreads or bear spreads, and they are useful in limiting the possible losses on any given trade.
5. Momentum Strategies
In this strategy, historical patterns, such as moving averages, levels of support and resistance, etc., are analyzed for hints as to whether a trade has hit its full potential or whether there is some more space.
6. Carry Style Strategy
This strategy involves speculators borrowing in a currency they anticipate to decline and need lower borrowing costs, and in turn, use the funds to purchase higher-yield currencies, such as the US dollar.See also Why Does the Currency Market Always Involve the Dollar
Although these hedge fund trading strategies can be an effective tool to balance the volatility in the forex market, their success depends on different factors, including government policies and the overall economic condition. Individual investors can learn these strategies and use them to their advantage since they deal in smaller trades that do not have a considerable effect on the overall trend.
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