“Hedged Fund” to “Hedge Fund”
The term that Alfred W Jones used was “hedged fund.” It promised the Shangri- la of investment strategies: profit without risk. Using a metric he called “velocity” – a precursor to what is now called beta, the measure of how closely a stock’s movement tracks the broader market—he split his holdings into two groups: good stocks that rose faster than the market in good times and fell slower than the market in bad times, and bad stocks that did the opposite. He took long positions in the former and short positions in the latter, theoretically ensuring that he’d make money whether the market went up or down. Shorting is the the way to make money when the stock falls. Read the very first hedge fund article The Jones Nobody Keeps Up With
Hedge Funds can short a stock, borrow a stock in hopes to sell it back for less (betting stock will go down). While Mutual Funds can only buy stocks betting that the stock will go up. Mutual Funds only make money on a Bull Market but hedge funds can make money in any market conditions.
Arbitragers, speculators and many individual investors engage in a practice known as shorting stock. These “shorts” make money when the price of the stock they are shorting goes down.
Famed investor Ben Graham told us there is nothing stopping an overpriced stock from becoming more overpriced. In the unlikely event the stock had shot up to $1,000 (which actually happened to shares of Northern Pacific during a short squeeze in 1902), you would have had to purchase ten shares at $1,000 a share for $10,000. Taking into account the $500 you received from selling the shares earlier, you would have lost $9,500 on a $500 investment.
Read Hedge Fund Math
Shorting Stock in Your Personal Portfolio
In order to begin shorting stock, you must open a margin account with your brokerage firm. You will be charged interest on the borrowed funds as well as subject to several rules and regulations that govern shorting stock (for example, you cannot short a penny stock, and before you can begin shorting a stock, the last trade must be an uptick or zero-plus tick.) After taking these factors into consideration, you will, hopefully, realize shorting stock is not a financially fattening activity in most cases.
It is important to note that hedging is actually the practice of attempting to reduce risk, but the goal of most hedge funds is to maximize return on investment. The first hedge funds tried to hedge against the downside risk of a bear market by shorting the market (mutual funds generally can’t enter into short positions as one of their primary goals). From That hedge funds have grown different strategies, so it isn’t accurate to say that hedge funds just “hedge risk”. In fact some hedge fund managers make speculative investments, these funds can carry more risk than the overall market.