Tuesday, March 3, 2009

Profit from Current Bear Market with Inverse ETFs

We have recently broke down below the major support level of 741/768 on the S&P 500 which were held recently and during the great bear market bottom of 2002.

This blog has set a target of 450 to 600 on the S&P 500 based on many factors.

Excellent Chartist Louise Yamada, who has been right so far, agrees with this assessment.

If you do believe that the market could go down from here (700 level) to 600 (drop of 15%) to 450 (drop of 36%), what can the investor do?

Conservative Method: Cash

The most conservative method is to increase the cash position in the portfolio. The next decision point would be when to start reallocating money in stocks again.

More Aggressive: Profit using Inverse ETFs

The more aggressive option is to purchase Inverse ETFs, or Inverse Exchange Traded Funds.

Exchange Traded Funds, such as the ticker symbol "SPY", are similar to indexed mutual funds, but they can be traded, and bought and sold just like stocks. You would normally pay a commission.

SPY, for example, represents the S&P 500 index. If the S&P 500 goes up 2x, the SPY would attempt to track that performance and go up 2x.

Inverse ETFs, on the other hand, are very similar, but they perform the opposite of the index.

For example, the inverse ETF "SH" is the Short S&P 500 ETF. When the S&P 500 goes up 2x, the SH goes down 2x. If the S&P 500 goes down 3x, the SH goes up 3x.

Another example is the double inverse ETF "SDS". This is the Ultra Short S&P 500 ETF. If the S&P 500 goes up 1x, SDS goes down 2x. If the S&P 500 goes down 1x, SDS goes up 2x.

These ultra and short ETFs are not meant to be investments, but trading vehicles.

Other Inverse ETFs from Proshares

Proshares is the company that provides many of the popular inverse ETFs.

Other examples include:
  1. DOG: Short Dow30
  2. MZZ: UltraShort MidCap 400
  3. SKF: UltraShort Financials
  4. SMN: UltraShort Basic Materials
  5. SRS: UltraShort Real Estate

Some of the UltraShort ETFs are very volatile and do handle them with care.

Trading Strategies

Using inverse ETFs is not meant to be an investment, but a trade. You should come up with a plan when to buy, when to sell, and know how to cut your losses.

You can use techniques as using limit orders (specifying the largest price you'll be willing to buy an ETF, for example), setting stop orders (in case you are wrong, you get to cut your losses quick), or even set trailing stops (as you profit, the stop order to sell follows your stock).

The strategies to trade these inverse ETFs are beyond the scope of this particular blog entry.

Stock Chart of SPY (S&P 500 ETF, Long)

Stock Chart of SH (Inverse or Short S&P 500)

Stock Chart of SDS (UltraShort S&P 500)

Stock Chart of SKF (UltraShort Financial)

Stock Chart of SRS (UltraShort Real Estate)

Stock Chart of QID (UltraShort Nasdaq 100)

Stock Chart of SMN (UltraShort Basic Materials)

Stock Chart of SIJ (UltraShort Industrials

Stock Chart of DUG (UltraShort Oil and Gas)

Stock Chart of REW (UltraShort Technology)

Stock Chart of EUM (Short MSCI Emerging Markets)

Stock Chart of EFZ (Short MSCI EAFE, International)

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