This strategy attempts to hedge out most market risk by taking offsetting positions, often in different securities of the same issuer.  Market-neutral strategies are often employed by taking matching long and short positions in different stocks to increase the return from making good stock selections and decreasing the return from broad market movements. Market neutral strategists may also use other tools such as merger arbitrage, shorting sectors, and so on. A market-neutral position may involve taking a 50% long, 50% short position in a particular industry, such as oil and gas, or taking the same position in the broader market. This strategy is most commonly used in pairs trading.  This is when you look at two different stocks in the same sector and buy the stronger stock with the hopes that it will appreciate. The position is then hedged by shorting a weaker stock in that sector. When the sector does poorly, the gains in the shorted stock will offset the losses in the stronger company.


There is no single accepted method of employing a market-neutral strategy.  Managers who hold a market-neutral position are able to exploit any momentum in the market. Hedge funds have traditionally been called market neutral as the nomenclature “hedge” means to offset risk.  Many hedge funds classify themselves as market-neutral because they are focused on absolute as opposed to relative returns.


Pros:  By being sector neutral you avoid the risk of market swings affecting some industries or sectors differently than others, and thus losing money when long a stock in a sector that suddenly plunges and short another in a sector that stays flat or goes up. There is usually low or no correlation to the market. The expected volatility of this strategy is low.


Cons:  A lot easier said than done. For example a pairs trade where the manager buys the stock of one company and shorts another in the same industry affords you two chances to be wrong.

An excerpt of “The Investment Survival Guide

By: Harvey Sax, Partner at Alpha Wealth Funds