Market Neutral Trading as an Investment Answer In Difficult Economic Times

The challenge to investors when there is a lot of market fluctuation is to find ways to minimize risk in unpredictable and difficult economic times. Market neutral trading is espoused as one good way to cope in a tough economy. There are several methods that market neutral trading investors use. While market neutral trading is accepted as a good way to approach a shaky trading marketplace, it is not without its own set of risks. During hard times when it is almost impossible to get a second mortgage or any kind of institutional loan, protecting investments and cash reserves is critical to manage financial health.

Market Neutral Trading Defined

Market neutral trading is accomplished by a trader going long on one instrument that is believed to be under priced and short on another that is perceived as overpriced in an effort to balance risk. This strategy can be used in a single market or in numerous ones. One example of this type of trading is taking long and short positions in the same industry, like selling Coke long and Pepsi short based on information that seems to favor Coke as a stronger player with better prospects in the soft drink market.

For this type of strategy to work, an investor must be able to expertly select a group of long stocks that will definitely perform better than the short stocks picked. Achieving a neutral trading position enables a trader to capitalize on market movements and momentum. Investors committed to market neutral trading often strive to be dollar neutral and sector neutral to minimize all risks by balancing long and short dollars and sector investment.

Analytical Approaches Used for Selecting Trades

There are two types of analysis used for selecting trade choices. Quantitative analysis involves the review of historical history and patterns to predict how a particular trade will perform in the future. Fundamental analysis is used for evaluating industry and company data as a means for determining long and short trade selections.

Challenges Inherent in Market Neutral Trading

While the logic behind this type of trading warrants special consideration as a way to survive troubling economic times, there are certain challenges that must be taken into consideration. There can be a need for a large number of buying and selling transactions, which presents certain problems. Being able to efficiently trade quickly and easily as needed is one challenge that must be met. Partnering with the best trading platform is crucial. Another cause for concern relates to the fact that transaction fees can become expensive when there are a lot of trades. This expense must be factored into the cost of market neutral trading and managed for higher returns.

Summary

Preserving assets in an economic climate where looking for no doc loans or an equity line of credit are as likely as winning the lottery, investors seek methods for minimizing risk in an uncertain economy. Market neutral trading presents one answer for conservative traders. Like most strategies, an investor is only as effective as his ability to select the complementary longs and shorts to trade.