Different Types of Hedge Funds: Equity Hedge Funds

Equity Hedge Funds

The premise of this type of hedge fund is to be market neutral and at the same time profit by buying under priced stocks and sell overvalued stocks. Hedge funds of this type try to eliminate as much of the market risk by choosing pairs which are within the same industry and market cap. They are also known as sector specialist” funds. They only want to profit from the relative difference in price. Long short hedge funds very often test the pairs to make sure that there is a lot of correlation between the two stocks. Very often one of the legs of the pair could possibly deviate from its fair price due to some market panic or irrelevant news and profit could be made by entering into the pair trade. Very often pairs trade within ranges and traders can profit by what are known as “mean reversion trades”. Pair traders also use a technique called “co-integration” which is a statistical term using historical data to test if a pair mean reverts. Pair traders often trade pairs within the same industry but different countries to take advantage of short term macroeconomic influences. Usually they would also hedge themselves in currency.