# Understanding Long-Short Equity Strategy: A Guide for Investors

## What Is Long-Short Equity?

Long-short equity strategies aim to take advantage of market opportunities by holding long positions in stocks anticipated to rise and [shorting](https://www.investopedia.com/terms/s/shortsale.asp) those expected to fall. This strategy seeks to reduce overall market risk and enhance profit potential, combining potential gains from appreciating stocks with benefits from declining stocks. Typically used by hedge funds, it's a [liquid alternative strategy](https://www.investopedia.com/terms/l/liquid-alternatives.asp) that can be tailored to various market conditions.

### Key Takeaways

*   Long-short equity is an investment strategy that profits by taking long positions in undervalued stocks and short positions in overvalued stocks.
*   This strategy aims to minimize market exposure while seeking profits from both appreciating and depreciating stock prices.
*   While commonly used by hedge funds, some employ a market-neutral approach by balancing long and short positions equally.
*   Pair trading involves offsetting a long position with a short position in the same sector to exploit price discrepancies.
*   Long-short strategies can differ based on market focus, investment philosophy, or industry sector, and are adaptable to various financial environments.

![Long-Short Equity: A strategy that involves taking long positions in stocks that are expected to appreciate and short positions in stocks that are expected to decline.](https://www.investopedia.com/thmb/x-eQdkNCjbyMX-oaJxyvF6MwvlA=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Long-shortequity_final-7719d98769c94bf4806fd86e75e0d1e3.png)

*— Investopedia / Michela Buttignol*

## Understanding the Mechanics of Long-Short Equity

Long-short equity works by exploiting profit opportunities in both potential upside _and_ downside expected price moves. This strategy identifies and takes long positions in stocks identified as being relatively underpriced while selling short stocks that are deemed to be overpriced.

Many hedge funds use a long-short strategy with a long bias, like 130/30, but few use a short bias. It is historically more difficult to uncover profitable short ideas than long ideas.

Long-short equity strategies can be differentiated from one another in a number of ways—by market geography (advanced economies, emerging markets, Europe, etc.), sector (energy, technology, etc.), [investment philosophy](https://www.investopedia.com/terms/i/investment-philosophy.asp) (value or growth), and so on.

A global equity growth fund is a broad long-short strategy example, while an emerging markets healthcare fund is narrower.

## Comparing Long-Short Equity and Equity Market Neutral Strategies

A long-short equity fund differs from an [equity market neutral](https://www.investopedia.com/terms/e/equitymarketneutral.asp) (EMN) fund in that the latter attempts to exploit differences in stock prices by being long and short in closely related stocks that have similar characteristics.

An EMN strategy attempts to keep the total value of their long and short holdings roughly equal, as this helps to lower the overall risk. To maintain this equivalency between long and short, equity market neutral funds must [rebalance](https://www.investopedia.com/terms/r/rebalancing.asp) as market trends establish and strengthen.

So as other long-short hedge funds let profits run on market trends and even leverage up to amplify them, equity market neutral funds are actively staunching returns and increasing the size of the opposite position. When the market inevitably turns again, equity market neutral funds again whittle down the position that should profit to move more into the portfolio that is suffering.

A hedge fund with an equity market neutral strategy is generally aiming itself at [institutional investors](https://www.investopedia.com/terms/i/institutionalinvestor.asp) who are shopping for a hedge fund that can outperform bonds without carrying the high risk and high reward profile of more aggressive funds.

## Pair Trading: An Example of Long-Short Equity Strategy

A popular variation of the long-short model is that of the “pair trade," which involves offsetting a [long position](https://www.investopedia.com/terms/l/long.asp) on a stock with a [short position](https://www.investopedia.com/terms/s/short.asp) on another stock in the same sector.

For example, an investor in the technology space may take a long position in Microsoft and offset that with a short position in Intel. If the investor buys 1,000 shares of Microsoft at $33 each, and Intel is trading at $22, the [short leg](https://www.investopedia.com/terms/s/short-leg.asp) of this paired trade would involve purchasing 1,500 Intel shares so that the dollar amounts of the long and short positions are equal.

The best outcome for this long-short strategy is if Microsoft stock rises and Intel stock falls. If Microsoft rises to $35 and Intel falls to $21, the overall profit on this strategy would be $3,500. Even if Intel advances to $23—since the same factors typically drive stocks up or down in a specific sector—the strategy would still be profitable at $500, although much less so.

To get around the fact that stocks within a sector generally tend to move up or down in unison, long-short strategies frequently tend to use different sectors for the long and short legs. For example, if interest rates are rising, a [hedge fund](https://www.investopedia.com/terms/h/hedgefund.asp) may short interest-sensitive sectors such as [utilities](https://www.investopedia.com/terms/u/utility.asp), and go long on defensive sectors, such as healthcare.

## The Bottom Line

Long-short equity is a versatile investing strategy that takes advantage of both rising and falling stock prices by going long on underpriced stocks and short on overpriced ones. Primarily used by hedge funds, this strategy can minimize market exposure and offers a way to profit in volatile markets. Variations, such as the 130/30 strategy and pair trades, adapt long-short equity to investor preferences and market conditions. While not without challenges, such as identifying profitable short opportunities, the strategy allows for a dynamic approach to investing across various sectors and geographies.