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A portfolio is truly market-neutral if it exhibits zero correlation with the unwanted source of risk. [1] Market neutrality is an ideal, which is seldom possible in practice. [2] A portfolio that appears market-neutral may exhibit unexpected correlations as market conditions change. The risk of this occurring is called basis risk.
A pairs trade or pair trading is a market neutral trading strategy enabling traders to profit from virtually any market conditions: uptrend, downtrend, or sideways movement. This strategy is categorized as a statistical arbitrage and convergence trading strategy. [ 1 ]
Market-neutral trading is a way to combine long positions with short ones. Rather than place your bets on upward or downward trends, this strategy takes advantage of volatility while mitigating risk.
Market neutral strategies can be seen as the limiting case of equity long/short, in which the long and short portfolios of the fund are balanced with great care so that a very high degree of hedging is achieved. Some advantages of market neutral strategies include being able to generate positive returns in a down market, and generating returns ...
These encompass a variety of trading strategies, some of which are based on formulas and results from mathematical finance, and often rely on specialized software. [5] [6] Examples of strategies used in algorithmic trading include systematic trading, market making, inter-market spreading, arbitrage, or pure speculation, such as trend following.
The trading strategy is developed by the following methods: Automated trading; by programming or by visual development. Trading Plan Creation; by creating a detailed and defined set of rules that guide the trader into and through the trading process with entry and exit techniques clearly outlined and risk, reward parameters established from the outset.