Making Money Alert
The Harder they Fall, the Higher they Bounce
03/25/2009
After a one-day pullback on Tuesday, the market was once again back in rally mode throughout most of the day. And despite a mid-afternoon pullback in stocks, the impressive gains we've seen on Wall Street over the past several weeks have pushed the value of the S&P 500 above short-term technical trend lines.
In the chart below of the S&P 500, we see that the broad-based measure of equities has now breached its 50-day moving average (blue line), a bullish sign for stocks going forward. The questions now, of course, are how long is this rally going to last, and is it for real?
The answer is that nobody knows for certain. But in my opinion, what we are seeing here still is a bear market rally, albeit a significant one. I think it should come as no surprise that given the huge decline in the market since September, any real bear market rally would be much sharper than past bear rallies.
The bigger they are, the harder they fall; and in this case, we see that the harder they fall, the higher they bounce.
So, what should you be doing with your money in this sharp bear market rally? Well, if you still have a lot of equity exposure, use the big up days to lighten your portfolio. That means selling some of your biggest losers in the face of market strength.
If you are looking to make short-term equity purchases, look for pullback days to enter into long opportunities. If you follow this strategy, make sure you put strict stop losses on all of your purchases. In a market like this one, it's easy to get burned in a matter of hours, so make sure you protect yourself on the downside.
Finally, if you are looking to follow a short-term trading strategy with a small portion of your investment capital, I suggest checking out my ETF Trader advisory service. The service is designed to take advantage of the swings we've seen in this market, as well as some of the lesser-known opportunities such as the current and growing disparity between the value of the U.S. dollar and rival foreign currencies.
To find out how to get your money positioned for short-term profits, click here
You've heard that old adage that there are two sides to every story. Well, today we bring you a side of the investment story from our friends at StreetAuthority.com. In his piece, Chief Investment Strategist Nathan Slaughter makes a great case for using short ETFs as a hedge against a reversal of the current market bounce. Enjoy!
Protect Your Portfolio Now with Short ETFs
By Nathan Slaughter, Editor, The ETF Authority
With the market rebounding sharply in recent days, now may be an opportune time to revisit an investment vehicle that produced incredible returns during this downturn -- inverse exchange-traded funds (ETFs).
Now ideally you hope that the market rally is legitimate and will hold, but it wouldn't be a bad idea to hedge against a renewed decline just in case. In this issue, we'll explain what inverse ETFs are, how they work and why smart investors should consider adding one or two in order to protect their portfolio.
Just a few years ago, investors interested in profiting from a downturn in a specific corner of the market had to borrow shares from their broker, short individual companies -- and then hope they didn't pick a stock that went against the grain and moved higher. But now, betting against banks, small-cap stocks, or even entire market averages is just one convenient ticker symbol away.
So, what exactly is this revolutionary new way to short the market? It's done by using an inverse ETF.
For the most part, I haven't placed terribly much emphasis on inverse funds in the past. After all, I'm generally a long-term investor, and ultimately the market goes up far more than it goes down. However, there are certainly times when this group can be very appealing, particularly in this market environment.
ETFs: A Brief Overview
Before we talk about the hedging advantages of inverse ETFs, let's quickly review what ETFs are, and how they work.
ETFs are securities that closely resemble index funds, but can be bought and sold during the day just like common stocks. These investment vehicles allow investors a convenient way to purchase a broad basket of securities in a single transaction. Essentially, ETFs offer the convenience of a stock along with the diversification of a mutual fund.
From a humble start in the early 1990s, the ETF business has exploded, particularly over the past several years. There now are over 700 ETFs with $450 billion in assets.
ETFs boast several major advantages over mutual funds and common stocks, including diversification, flexibility, low cost, liquidity, and tax efficiency.
Going Short the Smart Way
Inverse ETFs (or short ETFs) operate on the same basic principles, except they are designed to move in the opposite direction of an underlying index -- meaning shareholders actually profit when the benchmark tanks. In other words, these funds were made for markets just like this one -- the lower the market retreats, the higher these funds advance.
But it doesn't just stop there. Some ETFs can even return double the inverse of what the market is doing. Let's say you buy shares of the UltraShort S&P 500 ProShares ETF (SDS). If the S&P 500 drops -5%, then SDS gains +10%. Keep in mind, these funds compound daily, so if you invest for longer (a week, a month, a year) the returns won't line up.
These ultra-short funds are able to double the inverse performance of indexes by using leverage. The math doesn't always work out exactly, but you can usually expect it to return double the inverse within a reasonable range. The tradeoff, however, is that these funds can be incredibly volatile, and if you are wrong, you lose twice as much -- so only consider this if you think you'll have the stomach for it.
Think of inverse ETFs as a type of insurance policy for your portfolio. In other words, investing a modest amount in one of these funds can be a useful way to protect profits in certain asset classes or simply hedge against further market declines. And like any insurance premium, you hope it's never needed; ideally, the market reverses course and you end up realizing a small loss on the position that is more than offset by gains elsewhere.
But the events surrounding this recent downturn should clearly illustrate that sometimes unexpected circumstances can materially impact your portfolio, in which case an inverse fund can help soften the blow... and in some cases, even generate enormous profits.
For example, on Sept. 30, four days before the Dow went sub-10,000, I sent a special newsflash to my ETF Authority readers identifying 14 securities that could skyrocket as the market heads south.
As you can see, most of these have done exactly what they were designed to do in this rough market:
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*Source: Bloomberg. Total returns from 9/30/08 - 3/5/09
You may think you've missed the boat on short ETFs, but think again. With the market coming off of depressing lows, we may now be experiencing a "dead cat bounce," with the market rallying in an attempt to form a new bottom.
With all this in mind, readers might want to consider adding an inverse fund or two to help smooth out some of this unprecedented market volatility.
Good Investing!
Nathan Slaughter
Chief Investment Strategist -- The ETF Authority
StreetAuthority.com
839-K Quince Orchard Blvd.
Gaithersburg, MD 20878-1614
P.S. If you'd like to learn more about how to use ETFs to generate profits in ANY kind of market, I encourage you to check out my ETF Authority newsletter by visiting this link.
May the Force Be with You
"Try not. Do, or do not. There is no try."
-- Yoda, "The Empire Strikes Back"
There's a lot of sage advice in the Star Wars film saga, but perhaps the best comes from the unforgettable character Yoda. In this short, grammatically awkward burst of wisdom, we get one of the best pieces of advice anyone can ever receive. That is, if you are going to do something, do it. Don't just "try" to do it. To put it another way, if you are going to do anything in life, do it with 100% of your being. That is the way to "do" and not merely "try." And even though we don't always have control of the outcome when we "do," when we simply "try" fate has more control of the situation than it otherwise should. So go out there and "do" and do not merely "try."
Wisdom about money, investing and life can be found anywhere. If you have a good quote you'd like me to share with your fellow Alert readers, send it to me, along with any comments, questions and suggestions you have about my radio show, newsletters, seminars or anything else. Click here to Ask Doug.