How to Profit From Hedge Fund Selling

By: Geri Terzo

Hedge funds that short stocks bet that the stock price will fall.

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Hedge fund managers trade some of the most complex securities in the financial markets -- not only stocks and bonds -- and use strategies beyond just buy, sell and hold. They're not always right, but when they are, profits are higher than what the average investor earns. Not everyone meets the income or net worth requirements for hedge fund investing, however. To benefit when hedge funds are selling without actually being invested in the fund, you're going to have to be somewhat creative and willing to take some risks.

Regulatory Filings

Hedge fund managers are known for keeping trades close to the vest. Nonetheless, regulators require hedge fund managers who oversee more than $100 million to disclose their holdings each quarter. These filings are public, and by comparing a fund's stock holdings from one quarter to the next, you can observe what the fund has sold. Profiting from these changes isn't an exact science. If you model your portfolio after a hedge fund manager, you can sell when you learn the fund manager has lost interest in a company and earn a profit as long as the stock price has risen above your purchase price.

Jump on the Bandwagon

You may find that hedge fund replication indexes are more aligned with hedge fund trading strategies. These are index funds that copy the strategies of actual hedge funds but don't have the same income requirements or fees that hedge funds command. By investing in replication funds, you'll have exposure to hedge fund strategies and therefore profit when hedge funds profit. These funds aren't exact, either. Replication strategies can only be calculated monthly, while hedge funds don't have those limits.

Feeling the Pressure

In a perfect world, hedge fund managers would sell when investments peak and it's time to take profits. That's not always the case, however, and the reason is investor redemptions. This occurs when clients make withdrawal requests, and it can force the hand of hedge fund managers to sell at an inopportune time. In 2013, famed hedge fund manager Steve Cohen's SAC Capital received requests to return billions of dollars amid a regulatory investigation tied to insider trading. By pursuing the investments that a professional investor is fleeing for reasons unrelated to the health of the investments, you may find some profitable opportunities.

Market Dynamics

Not all asset classes, or investment groups, in the financial markets are correlated. In other words, when stock prices go up, you may find prices in another asset class, such as commodities, falling. In May 2013, hedge funds began heavily selling gold, a commodity, because there were no signs of inflation in the economy, and gold is frequently used as a hedge, or to protect, against inflation. Meanwhile, over in the equity markets, stocks were setting new record highs. When you see hedge funds selling in one asset class, consider another uncorrelated investment group for profits.

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About the Author

Geri Terzo is a business writer with more than 15 years of experience on Wall Street. Throughout her career, she has contributed to the two major cable business networks in segment production and chief-booking capacities and has reported for several major trade publications including "IDD Magazine," "Infrastructure Investor" and MandateWire of the "Financial Times." She works as a journalist who has contributed to The Motley Fool and InvestorPlace. Terzo is a graduate of Campbell University, where she earned a Bachelor of Arts in mass communication.

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