I'm very new to investing and after reading through the rules and a little about hedging, I'm a little confused. Why is it necessary for the algorithm to be long-short hedged and how hedged must it be?
My understanding is that long-short hedging two equities essentially results in investing in the difference between two equities. For example if I equally long MSFT and short QQQ, then I'm investing in MSFT's performance against the rest of the tech industry. If the industry as a whole goes down, I lose nothing, as the long/short positions cancel each other out. If MSFT outperforms the industry, which remains stable, I gain the difference. If MSFT underperforms against the industry, I lose money.
It's clear that this reduces market exposure but what's not clear is:
- How hedged our portfolios must be. From my reading it seems a 130/30 long/short hedged fund is fairly standard but the rules don't specify a particular desired hedge ratio.
- Why long-short hedging is a required method of reducing market exposure. The aim should be to reduce risk but there are other ways to do that, like derivatives, diversification or just adding more treasuries to the portfolio. It seems odd that long-short hedging is singled out and required for all entrants.
I'm new so I might not understand well but I thought it worth asking.