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Building A Successful Hedge Fund Strategy

Even with the recent upheaval and turmoil on Wall Street, it's still currently estimated that the hedge fund industry exceeds one trillion dollars in assets, and continues to expand. Hedge funds are all over the news, as their managers become multi-millionaires and seemingly come up with new, increasingly ostentatious ways to spend their massive fortunes. And until now, the average investor has been kept out of this world, being led to believe that one needs a MBA from a top university and millions of dollars to invest.

Why Not You? To pull back the shroud of mystery that surrounds hedge funds, let us debunk one of the pervasive myths about them up front. Hedge funds do not create any investment magic that you cannot create for yourself. In fact, hedge funds attempt to do the same things you do: buy low and sell high.

A successful hedge fund strategy has three basic attributes:

  1. Investment Discipline: This means developing a structured way of considering and acting on opportunities in the market. It is very important to have strong rules for entering a position and it is equally important--perhaps more important-- to have strong rules for selling out of a position. By sticking to a structured discipline, the investor yields more predictable results.
  2. Creativity In Expressing Your Investment Views: Find the right combination of tradable securities that reflects the risks and rewards you seek. If you believe that, say, rising energy prices will have an impact on the economy, you, the hedge fund manager, must determine what you can buy or sell that will position you to take advantage of this insight. Find the appropriate combination of investments to express your view precisely.
  3. Evolve Your Strategy As Market Conditions Change: Things change. Many a trader has bit the dust by sticking to a system that has already failed him. Conviction is an admirable personality trait, but when things are not working as planned, it is important to know when and how to move to Plan B.

There are some fundamental differences between you and the professional hedge fund manager. First of all, hedge fund managers spend a lot more time researching than you do, they have significantly more access to information resources that you do, and --perhaps--they are a bit more studied in mathematical finance.

In summary, hedge fund managers can take "intelligent" risks as a result of their access to a higher quality and quantity of information, they actively manage their market exposure; and the use (OPM) other people's money. You can express some of these features in your own portfolio.

An excerpt from the book Do-It-Yourself Hedge Funds by Wayne P. Weddington III.

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