Market-Neutral Trading Strategies (Rules, Backtest, Returns)

A market-neutral strategy is a type of investment approach that enables an investor to benefit from both rising and falling stock prices. This is achieved by taking long positions in one stock and short positions in another stock. The strategy is designed to reduce exposure to specific market risks and can be applied in one or more markets.

In this post, we take a look at market-neutral trading strategies, and we finish the article with a market-neutral trading strategy backtest.

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Market neutral trading strategies

Fund managers use different strategies to maximize returns and minimize risks for their investors. One of the strategies they use to hedge risk is market-neutral trading. This approach not only helps to reduce beta but also reduces systemic risks. But what are market-neutral trading strategies?

Here you can find more than 200 trading strategies similar to the above strategies.

What is a market-neutral trading strategy?

A market-neutral strategy is a type of investment approach that enables an investor to benefit from both rising and falling stock prices. This is often achieved by taking long positions in one stock and short positions in another stock. The strategy is designed to reduce exposure to specific market risks and can be applied in one or more markets.

The strategy balances the returns from well-selected stocks with the reduction in returns from broader market fluctuations, as the returns generated from this strategy are not affected by market swings and are not dependent on the actual price movements of the securities involved. This is why one of the main factors to consider when using a market-neutral strategy is identifying the type of market risk that needs to be reduced.

What are market-neutral strategies examples?

Hedge funds often use market-neutral strategies to exploit any momentum in the market while being protected from systemic risks. Holding a market-neutral position allows them to focus on absolute returns rather than relative returns. For example, Jim Simon’s Medallion fund most likely uses plenty of market neutral strategies.

An example of their market-neutral strategies may be to divide their budged capital into two and put half in a long position on one stock and the other half in a short position on a related stock, which could be a stock in the same industry or market sector. Holding 50% long and 50% short positions in related stocks or in the broader market affords them to balance out returns and reduce risks.

This way, if the market moves up, the losses from the short positions are offset by the profit made in the long investments, and if the market declines, the profits from the short position offset the losses from th