In their original conception, a hedge fund was essentially a fund that sold some stocks short, and bought other stocks (long). With this technique, the overall value of buying and selling balances out, thereby eliminating heavy losses due to large market swings; profit gains in a hedge fund rely on the choosing of appropriate stocks and acting on them at the most opportune moment.

The first hedge fund was created by stock pioneer Alfred Winslow Jones. Jones also used borrowed money to inject his funds with additional capital (leverage), and charged an incentive fee to his customers to place their money in his fund.

Hedge funds have evolved to include a number of strategies, in addition to the balanced short-long strategy of Jones. For the most part, the term hedge fund now refers to any mostly unregulated fund using unconventional methods of investing. Some common hedge fund strategies include: trading stock options and bonds, the purchase or sale of highly undervalued securities, and arbitrage. Most hedge funds also have the status of partnerships, rather than the corporate model of other funds.

A common hedge fund strategy is buying shares in a company that is in the midst of a merger and acquisition — in this case there is a guaranteed profit if the merger does complete, with the only risk being that the acquisition will fail. This strategy, often used in tandem with selling shares of the company doing the acquiring, is known as risk arbitrage.

Unlike mutual funds, hedge funds are very lightly regulated, and so can keep their actions relatively secret. Most contemporary hedge funds are handled by offshore companies in places like the Virgin Islands or Cayman Islands, where regulation is minimal. This secrecy makes it difficult to predict actual numbers for hedge funds, but estimates for 2003 were over US$650 billion under hedge fund management.

In order to keep regulation very low, hedge funds have the status of unregistered investment companies. This means that only accredited investors and qualified purchasers may invest in them — those who have incomes of over $200,000 per year or a net worth of over $1 million, or those who already have at least $5 million in investments.

The term hedge fund comes from the phrase "to hedge one's bets", and refers to the practice of balancing out transactions to ensure that no matter which way the market turns, a profit can still be made. It is this which distinguishes hedge funds from a spate of other fund strategies that sprang up at the beginning of the 21st century to capitalize on unconventional methodologies.