How to Make Money in the Stock Market With Hedge Fund Trading

Hedge funds can be lucrative.

Hedge funds have evolved greatly since their advent in 1949 by Alfred W. Jones. Once an exclusive, completely unregulated group of loose cannons, hedge funds today are more mainstream. Magnum Funds explains hedge fund methodology, stating "Hedge funds utilize a variety of financial instruments to reduce risk, enhance returns and minimize the correlation with equity and bond markets. Many hedge funds are flexible in their investment options (can use short selling, leverage, derivatives such as puts, calls, options, futures, etc.)." In short, a hedge fund is a high risk, high-potential instrument that, if you have excess money and a high risk tolerance, may be profitable for you.

Instructions

1. Research specific hedge funds very carefully. Hedge funds are not as regulated in terms of specific disclosures as their counterparts, the traditional mutual funds. They tend to use more speculative practices,such as leveraged investing, or borrowing money to invest, which demand a close look to see if you can tolerate the risk.

2. Evaluate hedge fund managers. Like a mutual fund, hedge funds develop a kind of cult following. While it is important to investigate hype, spend more time studying the long-term track record of the manager.

3. Invest incrementally if allowed by liquidity dates. Despite a large initial investment requirement, often between $10,000 and $100,000 or more, it is often prudent to invest equally over several consecutive months on a regular basis to attempt to purchase more shares when the price is low and more when it is high. This may not work if there is a high initial load, or fee, that is capped since you will pay this each time you invest, or if the fund only allows investment or liquidation yearly.

4. Hedge against your hedge. Invest a similar amount in more stable, fixed income investments such as municipal bonds or treasury bills to decrease the average risk of your portfolio.

5. Monitor your fund daily with specific government announcements in mind. Such press releases as unemployment numbers and inflation rates will cause swings in hedge funds. Since hedge funds often sell short, hoping their own specific stock will decline, the effects of these announcements on a hedge fund may seem counterintuitive.

Tips & Warnings

• Discuss hedge funds with your tax adviser, especially in terms of capital gains. There are more opportunities to have capital gains to tax when fund shares and individual stocks are churned, or bought and sold often and in high volumes. You may pay a large tax on a fund that does not make a large amount of money.

• Invest only disposable money in hedge funds.

• Analyze fee structures closely. Hedge funds often promise exorbitant return to justify extremely high fees of as much as 20 percent.

• Being too conservative with the prospect of higher inflation represents a substantial risk too.

• Evaluate the percentage of leverage, or borrowing, within the fund closely. This exponentially expands potential risk and reward.

References

• Magnum Funds: What is a Hedge Fund?
• Reuters: Hedgeworld
• Huffington Post: A Brief Explanation of Hedge Funds; Hale Stewart; June 25, 2007
• NY Times Online: The Beginner's Guide to Hedge Funds; Mark Atherton; December 14, 2007
• USA Money: A Primer - Hedge Funds, Private Equity, Venture Capital; Matt Kranz; August 17,2007
• New York University: Introduction to Hedge Funds; Neil A. Chriss; December 1998

Resources

• Eureka Hedge: What is a Hedge Fund?
• University of Iowa: What Is a Hedge Fund?; Emily Marriott, Isaac Ruiz-Carus & Varun Bhat