Long-short strategy is generally used by hedge funds. In simple words, an equity long-short strategy means buying an undervalued stock and selling(shorting) an overvalued stock. In normal circumstances, the long position will increase in value and the short position will decline in value. In this situation, the hedge fund will benefit. This strategy would work even if the long position declines in value but provided that the long position outperforms the short position.
Thus, the goal of any equity long-short strategy is to minimize market exposure, and get profit from a change in the difference between two stocks.
Let's take a simple example. A hedge fund takes a \$10 million long position in General Motors and a \$10 million short position in Volkswagen, both large automobile companies. With these positions, any event that causes all automobile stocks to fall will lead to a loss on the General Motors position and a profit on the Volkswagen position. Similarly, an event that causes both stocks to rise will have little effect, since the positions balance each other out. So, the market risk is minimal. But question arise, Why would a portfolio manager take such a position? Because he or she thinks General Motors will perform better than Volkswagen.
Equity long-short strategies which hold equal dollar amounts of long and short positions, are called market neutral strategies or long-short dollar neutral strategy (as described above).
Since, portfolio is immune to both upside and downside market risk, like risk free security, its performance must be measure from similar security ie riskless assets such as U.S. Treasury bill etc.
You can read more about market neutral strategy from here.
