Burger King s new fat-free burger, on the other hand, is dry and tasteless, producing moans in the back seat. What you have just done is become a market-neutral investor. Taking the McDonald s-Burger King example, if the market goes up, both your McDonald s and Burger King positions will rise in price, but McDonald s should rise more provided your analysis is correct and is ultimately recognized by other investors. Thus, the profit from your McDonald s position will more than offset the loss from your short position in Burger King. Typically, they make sure the baskets of long and short investments are beta neutral .
Beta is the measurement of a stock s volatility relative to the market.
A stock with a beta of 1 moves historically in sync with the market, while a stock with a higher beta tends to be more volatile than the market and a stock with a lower beta can be expected to rise and fall more slowly than the market. By being sector neutral , they 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. In effect, what managers try to do by being beta neutral, dollar neutral, and sector neutral is make their portfolios more predictable by eliminating all systematic, or market, risk. Fund managers must also trade in very liquid stocks usually stocks which have options written on them, indicating a high level of daily volume in order to ensure they can get quickly in and out of positions. The main variable, however, and the key to the success of this strategy is the fund manager s ability to select a basket of long stocks that will perform better than the basket of shorts.