How Do Hedge Funds Hedge Market Risk?, Python for Finance 13

TL;DR

Hedge funds traditionally seek to protect assets by hedging market risk, rather than simply trying to beat the market. Using Python, Quantopian, and Zipline, the tutorial demonstrates a long-short strategy that trades major-sector SPDR ETFs based on quick and slow moving-average crossovers while recording leverage to monitor overexposure. Read on to understand moving averages, short selling, asset protection, and the strategy’s early live-test results.

Transcript

what is going on everyone welcome to part 13 of our finance with Python tutorial series using kwang-ho pin and zipline in this tutorial we're going to be talking about building on top of this kind of long short strategy that we are working on so just to revisit that again we've got our the symbols that were interested in here are the spider ETFs fo... Read More

Key Insights

• 🍰 The long-short strategy in this tutorial utilizes moving average crossovers to determine when to enter short or long positions.
• 👻 Shorting in hedge funds allows investors to borrow and sell shares, aiming to buy them back at a lower price for profit.
• 💓 Hedge funds primarily focus on asset protection and avoiding market risk rather than solely beating the market.
• 🌥️ Hedging is crucial for large investors and companies to safeguard their assets and ensure more stable returns.
• *️⃣ Comparing hedge fund returns to the market benchmark like the S&P 500 may not be the most appropriate yardstick; diversification and risk reduction are key considerations.
• 🖐️ Hedge funds play a role in smoothing out market fluctuations, providing stability and predictability for asset owners.
• 🦔 Quanto Peon emphasizes hedging algorithms as they aim to cancel out market risk.

Questions & Answers

Q: What is the main objective of a hedge fund?

A hedge fund traditionally aims to hedge the market and reduce the risk of participating in it. For investors or companies managing very large pools of assets, protecting those assets can matter more than pursuing high-risk, high-yield returns.

Q: How does the Python for Finance 13 long-short strategy work?

The strategy trades SPDR ETFs representing the main market sectors and uses quick and slow moving-average crossovers to choose positions. It enters short mode when the quick moving average is below the slow one and goes long when the quick average rises above it.

Q: What is a moving average in this trading strategy?

A moving average is a moving window of average prices that smooths price fluctuations. A 20-day moving average, for example, averages today’s price with prices from the preceding 19 days and recalculates the value each day.

Q: Why are both quick and slow moving averages used?

The quick moving average reacts sooner when prices begin rising or falling, while the slow moving average takes longer to respond. Their relative positions provide the strategy’s signal for switching between long and short modes.

Q: How does short selling work in the strategy?

Short selling means borrowing shares, selling them, and intending to buy them back later. The goal is to repurchase them at a lower price, return the shares to their owner, and retain the difference.

Q: Why should a trading algorithm record leverage?

The tutorial recommends recording leverage because an account can be overleveraged very easily. The presenter therefore records it in essentially every strategy he writes.

Q: How did the strategy perform during its early live test?

The presenter began live-testing the strategy on the 17th. Although it had lost money by the time discussed, it was performing about four times better than the declining market at that moment.

Q: Why is beating the S&P 500 not the only measure of a hedge fund?

The tutorial argues that market-beating returns are not always the primary goal for investors managing billions of dollars or for companies protecting assets. A hedge can be valuable when it offsets market declines and makes the combined result close to zero, thereby reducing market risk.

Summary & Key Takeaways

• The tutorial focuses on building a long-short strategy using moving average crossovers and the Spider ETFs, explaining the concept of moving averages and the benefits of recording leverage.

• It discusses the results of the strategy and explains how shorting works by borrowing and selling shares with the intention of buying them back at a lower price.

• The tutorial also emphasizes the importance of hedging in hedge funds, dispelling misconceptions about finance and highlighting the goal of asset protection.