Trading the Day Away: Do Hedge Funds Day Trade?

In day trading traders buy the financial securities in mind selling them the same day. When buying securities they are very well aware of the news and prospects. With that in mind, they do a quick buy and sell with the intent of a quick turnaround. Hedge funds are known for their long-term investments, but do hedge funds day trade?

No, hedge funds are not frequent day traders, but can utilize day trading techniques to lower trading risk. Fund managers then employ high-frequency trading, news-based trading, and other techniques. The increase of day trading and trading platforms is pushing fund managers to from time to time move to day trading.

But, what techniques do they use? When do hedge funds do day trade? Are there specific laws and regulations that they need to follow? Stay with us and learn about this hedge fund trading technique.

Understanding the Essence of Day Trading in Hedge Funds

Day trading is a practice that hedge funds sometimes employ to conduct short-term trades in a single day. The goal is to catch and take advantage of intraday price movements. Trading can be done with several securities like stocks, currencies, derivatives, or commodities.

Elements that define the essence of hedge fund day trading are:

• Short-term time window. When conducting day trade, funds want to capitalize on short-term price fluctuations. Trade positions are open and closed on the same day. So the only way to capitalize on gains is to catch interday market movements.
• Constant monitoring of the market, and fast execution. The managers must follow the news, the market, and the technical indicators throughout the day. That is the only way to catch current market gain possibilities. They need to take advantage of every moment because it can be the difference between a loss or a gain.
• Constant technical analysis. To be able to spot all the fluctuations and price changes managers must conduct technical analysis of the market. That way they can catch the trends, patterns, and other indicators on time. For this purpose, they use charting tools and quantitative models.
• Money and risk management. The short-term trades carry with them the highest risk level. That is why effective risk and money management is essential for day trading. To minimize the possibility of losing on a trade, managers use several risk management techniques. The most common ones are stop-loss order and position sizing techniques. When the stop-loss technique is used the investor pays the trader to sell a security once it reaches its predetermined price limit. Position sizing is a technique used to determine the amount of dollars that the investor is going to invest in trade. This way they control risk and maximize gains.
• Fund manager’s specialized skill set. Valued day trade managers have a wide knowledge of market dynamics, knowledge, and experience in conducting technical analysis. Proficient managers also are good at handling stress and making quick and key decisions. This set of skills sets them apart from other fund managers.

Check out How The Hedge Funds Trade:

When Do Hedge Funds Day Trade

Hedge fund managers sometimes take advantage of news-based trading. This type of trading tends to utilize the major sudden changes in the market. These changes are often the result of economic, and political decisions. Sometimes, other types of news can have a big impact in a short period on the trading market. News that can make a difference in the trading world are:

• Geopolitical events. In this group, we can put elections, wars, economic tensions, or other news that impact the world
• Mergers and acquisition announcements. News that announces a major takeover, mergers, and restructurings will push fund managers into day trading. These events can trigger great opportunities for short-term income returns
• Releases of economic data. Economic data are released periodically. Those data include unemployment figures, recorded and planned GDP growth, and changes in interest rates. This information can trigger sudden changes in the market. These changes can be exploited by the fund managers
• Earnings reports. These reports are released a few weeks after every quarter. If the managers find interesting information that can be used for short-term gain, these reports can be a breakthrough
• Missoclenius corporate news. Changes in management, new marketing strategies, and releases of new products and services. This news can create potential returns in the short term.

Who Decides to Day Trade in Hedge Funds?

In case the funds are involved in day trade, they have fund managers who specialize in short-term trading strategies. They are constantly monitoring the market and conducting trades. It is their decision when will they enter and exit a trade. They base those decisions on technical and algorithm analysis, the state of the market, and recent news events.

Since hedge funds do not frequently enter into day trade, this decision is usually triggered by the investment strategy and objectives.

Tools of the Trade: Techniques Employed by Hedge Funds for Day Trading

Hedge funds do not employ day trading as a routine. But, they can use it to take advantage of short-term market fluctuations and changes. Day trading is a high-risk strategy, and it is not suitable for everyone.

• Traders often employ high-frequency trading (HFT) strategies to conduct large numbers of sales in a short time frame. That involves using advanced algorithms and technologies. HFT strategy is an algorithmic type of trade that requires high-tech computers. That way the traders can analyze the market with large quantities of information in a short time. They look for small discrepancies in the market, to capitalize on the returns
• Hedge fund managers use statistical arbitrage as a daily trade technique. This is a sophisticated mathematical technique for trading financial market assets. Those often include equities and commodities. With the use of statistical arbitrage managers analyze large quantities of data. With it, they tend to identify the temporary and hard-to-identify mispricing between securities
• One of the most common statistical arbitrage techniques is pair trading. It involves identifying two companies with similar backgrounds. Their stock prices are often moved up and down simultaneously. If shares of one of the companies suddenly lose value, they buy the shares of both companies. Then they wait for the value of the shares of the first company to go up. Also, they short-sell the shares of the second company, because it is anticipated that they will go down. But, hedge funds do not limit themselves to one pair of companies on the market. They go and buy all over the market and buy different pairings. That way they have a higher chance of making big returns
• Scalping is a day trading technique in a stock market used by traders. Hedge fund day traders also often use it in combination with high-frequency trading and advanced algorithm calculations. This technique is based on making many smaller trades throughout the day. The goal is to capitalize on small price market movements. In scalping it is assumed that all bought stocks will start with advances. After some time some stocks will stop advancing, while others will continue. Hedge funds day traders must have a defined exit strategy. If he misses the time to exit he can end up with considerable losses that cannot be covered. A fund trader can still end up winning if the minority of trades are positive if the positives are large. But, traders aim to have a majority of wins, even small ones
• Momentum trading is another trading strategy employed by hedge fund traders. Momentum trading aims to utilize the upward or downward trend in a stock. Their philosophy is that if the stock has momentum, it will drive it in the same direction. The one big issue with momentum trading is the high risk of volatility. Momentum’s trading goal is to capitalize on market volatility, but if the exit strategy is not good, it can lead to large losses
• Mean reversion is a theory that securities value will in the end return to their overall state. Fund managers use mean reversion to identify when the price of security recently significantly dropped from its average. Then they buy it with the anticipation that the price will return to its average value. Then they reap the benefits of the price correction
• Market making is a technique used by hedge fund managers. In this technique, the hedge funds provide liquidity to the market. They offer to both buy and sell securities at competitive prices. This requires large amounts of securities needed to facilitate the volume of purchases and sales. Because of that, only large hedge funds can use this technique. The traders make a profit from the difference between the buying and selling prices. They aim to capture small profits on most of the trades
• Hedge funds also use sophisticated algorithms to automatize their trading strategies. These algorithms are used to process large amounts of data. This way it is easier to spot fluctuations and identify patterns. This helps hedge funds take advantage of short-term trading options. With all that information properly analyzed sales can be done at a very high speed minimizing the possibility of risk.

Rules for Hedge Funds in Day Trading

Day trading for hedge funds is tightly regulated. To be able to day trade, hedge funds must comply with several regulatory requirements connected to day trading:

• Follow the Securities and Exchange Commission (SEC) Rules. In the United States, hedge funds are subjected to the rules of the SEC. There are several specific regulations that funds may need to follow, and those can vary. But, the most important rules to follow are Regulation T and Regulation SHO. According to Regulation T, an investor can borrow up to 50% of the purchase price of the securities. The other 50% must be funded with cash. The regulation SHO is focused on rules for conducting short-selling
• Upholding to the pattern day trading rule (PDT). This regulation is enforced by the Financial Industry Regulatory Authority (FINRA) in the United States. It refers to the traders and brokers that conduct four or more day trades in a rolling five-business-day period.
• Following through on anti-money laundering (AML) regulations. All other financial institutions, including hedge funds, are required to comply with the anti-money laundering regulations. When hedge funds engage in day trading, they may need to follow all strict AML policies and regulations. This includes conducting a customer due diligence process (DCC) that includes gathering and verifying information about customers. They also need to report any suspicious activities to the relevant regulatory institutions
• Complying with market manipulation and insider trading regulation. These regulations are in place to prohibit and prevent illegal activities that can have an impact on market prices. Also, they aim to prevent providing unfair advantages to certain market participants. Hedge funds that enter into day trading need to ensure that their trading practices are in check with these strict regulations. In some cases, they have to organize teams and systems to prevent any prohibited activities
• Upholding all specific jurisdiction regulations. Those include different laws and regulations that impact the business of hedge funds day trading activities. They are different in other countries and systems. When conducting day trading business in the EU, they have to comply with the European Market Infrastructure Regulation (EMIR) and the Markets in Financial Instruments Directive (MiFID II). This regulation specifies reporting, transparency, and investor-protecting policies and requirements.

Real-World Examples of Day Trading Hedge Funds

Most hedge funds use medium and long-term trading strategies. However, some funds complement their strategies with the use of short-term strategies. Those strategies can have a day trading component that helps them supplement their trading strategies. Some of the examples of these funds are:

• Renaissance Technologies. This fund is known for its success, but they do not have a specific focus on day trading. They are known for their quantities trading strategies. They often use complex algorithms and different mathematical models. That way, they identify short-term trading opportunities
• Two sigma. They are a quantitative hedge fund that uses data-driven strategies and advanced automated technologies in making trade decisions. They often use short-term trading practices, including day trading. They aim to capture sudden stock market fluctuations and get substantial returns.
• D.E. Shaw & Co. They are known as a fund that developed different complicated mathematical methods and computer programs. These techniques help them identify and exploit anomalies in the financial market. With these methods, they can often rely upon risky short-term strategies. They are actively combining long-term investments with day trading and other short-term strategies
• Citadel. They are one of the best examples of a fund that utilizes high-frequency trading and market-making techniques. They use advanced quantitative models and advanced trading technologies. With those, they capture discrepancies in the market. These methods offer them an increased probability to step up their short-term and day trading strategies.

Learning from the Experts: Trade Like A Hedge Fund Manager

All well-known fund managers who are using day trading to boost their returns agree on several aspects.

• Defining the strategy. Some day traders use technical and analytical systems of charts and probability. Others are fundamental analysis that includes following news and market data. Some are combining these two. Also, a popular strategy for hedge fund day traders is pair trading, which includes trading currencies.
• Defining the timeframe. The moment you enter or exit the trade is crucial. If you entered the trade at the wrong time, you will probably end up losing. Also, if you wait too long, you can get the same negative result. Also, an early exit can miss out on a major upside. There are 4 strategies for entering and exiting the trade: single entry, single exit; single entry, multiple exits; multiple entries, single exit; multiple entries, multiple exits.
• Trading psychology. Every fund manager has its ups and downs. Sometimes, even if you do everything the right way, the market can shift the other way. You need to be physically prepared to take losses.
• The correct mindset. To conduct successful day trades, you must be able to conduct trades in a very fast-paced environment. If you are a little late, you can end up with huge losses. That can ruin much more than a day. To achieve success in this type of trading, you need to create a trading plan. You must be calm and keep a professional distance. Follow through on your plan, and at the end of the day, weigh up your losses and wins. Do not let anything, especially personal judgment, make the worst of you.

Overcoming the Challenges: Mitigating Risks in Day Trading

• Risk and volatility play a major role in day trading. Although hedge funds use several high-risk investment strategies, day trading is a risk on another level. Making quick decisions with often leveraged funds can result in large losses. Frequent market fluctuation up and down is called market volatility. If it happens, that increases the risk of trade and raises the possibility of losses
• For the hedge funds to enter the day trade, they need to fulfill certain legal requirements. Hedge funds are often restricted in this type of trade. The typical restrictions include frequency or volume of trades. Hedge fund traders also need to register so they can participate in day trading. They are also obligated to comply with need for specific reports and disclosures.
• Hedge funds often dedicate managers or whole teams of traders for day trading. They closely monitor the markets intending to conduct day trading. For trading securities, they typically use currency, bonds, stocks, and futures.

FAQs

What Kind of Algorithmic Trading Do Hedge Funds Do?

Hedge funds commonly conduct these types of algorithmic trading:

• Trend-following
• Mean reversion
• Statistical arbitrage
• High-frequency trading
• Event-driven strategies.

Do Hedge Funds Do Swing Trading?

Yes, hedge funds do swing trading. When using a swing trading strategy, hedge funds take a position in a specific asset. They look to identify and capitalize on short-term and medium-term price swings. A swing trade can be completed in a matter of a few days, but it can be prolonged to several weeks.

Hedge funds analyze price patterns and other relevant market data to identify the entry and exit points. They do not aim to capture the whole trend from start to finish. Instead, they just want to make a profit from price fluctuation that takes place in a trend.

This technique is best suited for those hedge funds that focus on short-term trading opportunities. In swing trading, a trader’s goal is to generate returns from both the upper and downward price movements. Like all short-term trading techniques, it comes with risks. However, these trades can bring large profits when compared to long-term investments.

How Often Do Hedge Funds Day Trade in the US?

How often hedge funds day trade depends on the hedge fund strategy. The majority of funds are rarely included in daily trades. On the other hand, some funds use daily trades as a significant part of their investment strategies.

There are day trade experts in the funds that can bring considerable returns from the stock market. But, daily trade is overall not a favorite hedge fund strategy. Another factor that can impact the frequency of day trades is the regulations under which the fund operates.

Final Considerations

Day trading is not a favorite tool of trade for hedge fund managers. But, in recent years, day trading has increased, and it lowered the returns of hedge-fund long-term investments. That is why, from time to time, fund managers participate in short-term trading and day trading activities.

Successful managers use quantitive and algorithm methods to identify short-term trading possibilities. A major role in day trading is also understanding and closely following both the market and world impact news. A day trade manager must have the correct mindset, a lot of experience, and must understand short-trading psychology.

It is important to note, before conducting day trading, that it is strictly regulated. This regulation is also applied to hedge funds. Its goal is to monitor the amount of borrowed money and prevent money laundering.