Directional Strategies: Strategies in this category involve buying or/and selling securities or financial instruments that the markets believe to be significantly overpriced or underpriced relative to their potential. These strategies include taking bet on the market or security movement forecasting. The profits of Hedge Funds specializing in this area depend on the ability to forecast price accurately as well as predict the exact timing of these movements.
An important example of equity long/short strategy is pairs trading. It consists of the combined purchase and sale of two securities of similar sector; the rationale behind it being that one security is overvalued relative to the other. Over time, as the market moves itself, the pairs trading strategy should yield positive returns as the prices of two securities converge in long-term irrespective of movements in the general market. Pairs trading is not restricted to equity securities and can be applied in other asset also classes.
Related to this strategy, there are similar other strategies followed in this section; they are: