Buying Assets for Strategic Gains through Hedge Funds - dummies

Buying Assets for Strategic Gains through Hedge Funds

When a hedge fund manager or other investor buys a security, he or she is said to be long. An investor has only one reason to go long: He or she thinks that the asset will go up in price.

Some hedge fund managers look for longs that will work over an extended period of time — possibly years — and others prefer to make their profits over very small stretches of time — possibly seconds.

The secret of making money is buying low and selling high. So what marks low and high? Answering this question is where research comes in. The research sets the price targets for establishing and selling the position.

The fund buys the security (with cash on hand or with leverage) and holds it until it reaches a higher price or sells it if it becomes clear that the investment isn’t working out. The difference between the purchase price and the sale price — adjusted for borrowing, interest, and commissions — is the profit (or loss) for the position.

The hedge fund structures of light regulation, limited investor liquidity, and maximum return for a given level of risk very much favor trading. For this reason, many hedge funds are aggressive traders: They often take positions for only a very short time. They look to capture small increases in price, but they do it every day, over and over again, so that the amounts compound into a very large return.

Some hedge funds take a long-term outlook with their securities, meaning they buy and hold to establish a position and then wait weeks, months, or even years to be proven right. The buy-and-hold style is less common in hedge funds than in other investment vehicles, such as mutual funds or individual accounts, because the hedge fund structure is less of an advantage to the investor with a long-term outlook than to the active trader. Still, many hedge funds do buy and hold — especially if they’re playing with private and illiquid investments.