Market neutral investing is a stock market trading technique that seeks to profit from buying both bullish stocks and shorting bearish stocks at the same time. In other words, you aren’t 100% long or 100% short, but using a market neutral strategy you are in both long and short positions and hoping that your shorted stocks will go down in price while your long stocks will go up in price. However, you don’t just buy $50,000 in a long stock and short $50,000 of another stock, but somehow pick the quantities so that various investment risks cancel out.

Hedge funds specialize in creating market neutral strategies. Regardless of market swings up or down, and regardless of whipsawing volatility, they create market neutral portfolios designed to take advantage of any way the market turns.

If the market goes up and their risks are balanced, their short positions will go up less than the market does and their long positions will go up more than the market does. That spread differential creates a profit. If the market drops, their judiciously selected short positions will drop faster/more in price proportionately than the market, and their long positions will hold steady or drop less. Once again, they hope to make money from the spread differential and thus they don’t worry about market volatility anymore.

Buy-and-hold investing is not the target of market neutral strategies. Market neutral funds shoot for absolute returns as opposed to relative returns. Fund managers want relative returns, so they’re fond of saying things like the market fell 12% this year and we only fell 8% so we did better. A market neutral manager wants to say something like the market dropped 12% this year but we made 10%.

If your risks are balanced and you take equally weighted longs and shorts, with a market neutral strategy you don’t worry about wild market swings at all. At worst your portfolio return is zero because your longs and shorts balance out, whereas if you select them correctly you make a large differential.

There is no single one way to create a market neutral strategy. Hence many market neutral stratgeis and investing styles are possible. However, you can create a market neutral strategy on your own by using correctly computed factor seasonals. Here’s how.

For every good or bullish stock that you decide buy according to the strategy you will sell an equivalent amount of bad or bearish stock short. In this way you are balancing your portfolio, or hedging it, so that your portfolio’s investment performance will not depend on the overall market direction, but on your stock picking abilities. You’re betting that your good stocks rise and in fact outperform the bad stocks that you sold short, which you hope will decline. This is market neutral investing.

In fact, you can even do this and create your own personal big cap hedge fund with big stocks like the Dow Jones Industrials. Here are the traditional times of the year in which these stocks geneally go up or down, though of course we always project this into the future with our orange projection lines, which can radically change the general dates. I’m just showing you that even with the institutional big cap stocks, there are traditional times of the year when each stock tends to go up or down based on its own economic cycle.

Up Jan-May

Down Sept-Nov

In a Bear Market, up Feb-May, Nov-Dec

In a Bull Market, down Feb-Apr, Jun, Sept-Nov

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