Long short strategy

[jcjc0602]

In general, a long-short strategy does not stay market neutral but invests on both the long ans short sides of the market. Which of the following is false?
I. To implement this strategy the manager invests on both the long and short sides of the market
II. this strategy builds on the momentum strategies of buying winners and selling losers
III. This strategy helps balance the market by providing desirability to the losing stocks and increasing inventory of the winers
IV. the extra trading due to the long-short strategy tends to increase market volatility
A. I, II, III and IV
B. II only
C. III only
D. II and IV only

solution is D. How can we decide whether the long-short strategy will buy winner and sell loser or the other way around? In other word, how can we choose between II and III?

 

[ShaktiRathore]

Hello,
Strategy II seems false as it is more like a value based strategy that is buying winners and selling losers where there is no hedging.Its purely fundamental based investing. Whereas the long-short strategy will invest on both long and short positions but will tilt slightly in favor of short or long position so that to protect against large losses due to negative movements but at the same time cashing on in favorable movement for the long-short position. The long-short strategy provides desirability for losing stocks by having short position in them and a slightly tilted long position in winners increases their inventory. e.g. buying 20 shares of winner X and shorting 19 shares of loser Y. In this way Y is desirable as it is involved in investor's position (short now and buy Y later so there is desirability for Y among investors) and X is relatively increased by 1 in inventory. The strategy helps balance the market in this way between loser and winners by increasing inventory of the winners. III thus seems true.

thanks

 

[jcjc0602]

Hello,
Strategy II seems false as it is more like a value based strategy that is buying winners and selling losers where there is no hedging.Its purely fundamental based investing. Whereas the long-short strategy will invest on both long and short positions but will tilt slightly in favor of short or long position so that to protect against large losses due to negative movements but at the same time cashing on in favorable movement for the long-short position. The long-short strategy provides desirability for losing stocks by having short position in them and a slightly tilted long position in winners increases their inventory. e.g. buying 20 shares of winner X and shorting 19 shares of loser Y. In this way Y is desirable as it is involved in investor's position (short now and buy Y later so there is desirability for Y among investors) and X is relatively increased by 1 in inventory. The strategy helps balance the market in this way between loser and winners byincreasing inventory of the winners. III thus seems true.

thanks

Thanks for your reply! "The long-short strategy provides desirability for losing stocks by having short position in them and a slightly tilted long position in winners increases their inventory." I thought longing winners will accelerate its increase while shorting losers will exacerbate them to decrease further. In your example, I am not sure why Y is loser and also desirable. Is that a contrarian trading?

 

[ShaktiRathore]

As far as i understood,
shorting losers does not mean that these losers will be exacerbated but that losers are still under consideration by the investors because while u settle the short position you do it by going long in the losers so in the end there is not decrease in the losers position in the market but that losers positions are still considered by investors by investing in them through simultaneous short and long positions. hence there is desirability of the losing stocks among the investors in this strategy.

thanks

 

[Aleksander Hansen]

This questions is not properly specified.
I. is true by definition of the question.
II. III, and IV can be either true or false in any combination depending on the market. IV. can be true if you suddenly observe a lot of high-frequency trading in a stock for example; you will see increased volatility and decreased bid/ask spreads.
Note that III. is not a consequence of the strategy itself, thus it is ambiguous. Indeed, you can drive the long/short the other way, or all the way down where it begins to revert and the spread increases.