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)

Stock Trading Ideas after Stock Market Drop Today

The S&P 500 went down 52.54 points today, to close at 806.58, a drop of 6.12%.

The S&P 500 broke below previous support of around 839 and 818.

We previously wrote what could happen if the S&P 500 breaks below 839, or even if the S&P 500 breaks 768.

This can be a very scary market, but for traders, this can be a great market. Traders like volatility. For many years, the US Stock Market had been trading at below average volatility, and it was just a matter of time before the stock market reversed itself and entered a high volatility phase. We are currently experiencing this high volatility.

Using SPY as Trading Vehicle

One trading vehicle is to go long (profit when stock goes up in price) or short (profit when stock goes down in price) the SPY, the S&P 500 ETF

The SPY attempts to mimic the S&P 500 index, but it is not a perfect match. In general, the SPY is currently at $81.50, and the S&P 500 ($SPX) is at 806.58, an approximate ratio of 1 to 10.

Using Inverse ETFs to Trade

Alternatively, you can use the inverse ETFs at Proshares.com.

Some of the products include:

1. SH: ETF that goes up 1x if the S&P 500 goes down 1x, and ETF that goes down 1x if the S&P 500 goes up 1x.
   
2. SDS: ETF that goes up 2x if the S&P 500 goes down 2x, and ETF that goes down 2x if the S&P 500 goes up 2x.
   

So rather than shorting the SPY, you can go long on the SH. Of course, the behavior and value of SH differ from SPY.

Trading Ideas After Stock Market Drop Today



The S&P 500 broke below previous support of 839 and 818 (on an intraday basis), and it appears as if we are in a breakdown and the SPY is trying to find a trading range.

We expect the upper band of the trading range to be previous support at around 839. It is known that what was once support now becomes resistance.

On the downside, it appears that 768 appears to be the next major bottom. This 768 bottom was reached October 10, 2002, 6 years ago, in a major bottom after the 2000-2002 Bear Market.

So if the S&P 500 ever reaches 768, we do not expect it to break through 768 right away. It should respect the 768 major support at least once.

So how can we formulate a possible trading plan?

A) First Trading Idea: Short SPY here

This plan refers to trade A) in the chart above.

We know upper resistance on SPY is around $83.50. And since the SPY recently broke down below this (ideally, with high volume), the short term trend appears to be down. In fact, it is possible that the SPY can shortly re-test resistance at $83.50 before continuing down.

The first trading idea is to short the SPY (or go long on the SH), around these levels.

Where is a possible bottom?

As we discussed earlier, $76.80 is a good target on the downside, and a single re-test of the October 10, 2002 lows should be in order. This is a major bottom.



We can cover the short near this area.

B) Second Trading Idea: Go Long SPY at $76.80

Since we expect at least a single re-test of the $76.80 levels, we can cover our previous short, and then go long SPY.

Where can we cover? We do not know how far the rally can last, but the resistance area of $81.80 to $83.90 area would be good bets.

C) Third Trading Idea: Short SPY after rally to $82

Once the rally runs out of steam, we can sell our previous SPY long position, and go short for the estimated re-test of the SPY low of $76.80.

We do not know whether the re-test at $76.80 will succeed or not, so it is best to cover the short around this area.

D) Fourth Trading Idea: If SPY breaks $76.80 to the downside, Short SPY!

If the SPY finally breaks the major support of $76.80 to the downside, it is time to short SPY because this would be a very bad scenario for the market, but an opportunity for you to profit.

Use Limit Orders, Stop Orders and Trailing Stops

This is a very fast moving market. If you cannot monitor the stocks every moment of the day, you can use limit orders, stop orders and trailing stops.

Today SPY is at $81.50. Let's say during this time, you put in a Limit Order to Buy at $76.80 (good for 60 days).

SPY starts going down (your order has not been executed at this time) but has not reached $76.80. Then several days from now, SPY reaches $76.80.

After purchasing SPY at $76.80, you then put in a Stop Order to Sell at $75. You expect SPY to bounce at $76.80 and go higher. If this happens, this is good, and you eventually take your profit.

But there are times when you are wrong. SPY could continue falling below $76.80 and when it hits $75, your SPY order to Sell will be active.

Is it possible that SPY reaches $75, hit your stop order to sell, then start climbing upwards again? Yes, this can happen. But it is good to remain disciplined, and stick to the rules.

You can also use Trailing Stops as a technique to limit losses, and to protect profits.

Let us Monitor the Situation

Of course, we should monitor the situation at each stage, and we should remain disciplined.

Today's SPY Chart

Today's S&P 500 Chart ($SPX)

The Warren Buffett Challenge (and Index Funds)

Warren Buffett, in the 2007 Annual Berkshire Hathaway Conference, has some interesting comments.

Warren Buffett even offered a challenge:

Name at least ten hedge funds that will beat a low-cost index funds.

His point? For "a know-nothing investor, a low-cost index fund will beat professionally managed money." But you might ask why didn't Mr. Buffett take his own advice on index funds? Warren Buffett said that he thought could beat the S&P by a couple of percentage points, "just not a whole lot better."

Other gems selectively taken directly from a Leslie McFadden Article from BankRate.com:

1. Read and think before you invest. When a 17-year-old who was attending his 10th consecutive Berkshire annual meeting asked how to become a better investor, Buffett offered some simple but golden advice. Read everything on investing you can get your hands on and fill up your mind with various competing thoughts. After doing that, it's time to get started, as investing on paper and dealing with real money is like "reading a romance novel and doing something else."

He added that when you think about buying shares in a company, think about why you might buy the whole business. If you couldn't write an essay about it, then you shouldn't buy any shares.

2. Risk is tied to the type of business and ignorance of the investor. One investor from Los Angeles asked about using volatility as a measurement of an investment's risk. "Volatility does not determine the risk of investing," Buffett said, adding that risk comes with certain kinds of businesses and not knowing what you're doing. A better approach would be to understand the economics of the business you're investing in, he said.

3. What can be done about shorting stocks? "I have no problem with shorts," says Buffett. He added that he didn't think shorting stocks poses any threat to the world. He would be fine with it if someone wanted to short Berkshire stock.

4. Better to invest in businesses tough for competitors to enter. Asked about his interest in investing in Taiwanese high-tech companies, Buffett remarked that "change is wonderful, but not necessarily for investments." In terms of predicting how a business will perform, he said it's much easier to look at consumer behavior and businesses that have big barriers to entry, citing Gillette as an example of a company with a 70 percent market share for men's razors.

5. Value investing -- what else is there? One person asked about whether Buffett's value investing strategy would apply in South Korea. Buffett said investing is all about value. "What other kind of investing is there?" he asked. "Are we going to have nonvalue investing? Are we going to have tipster investing … dream investing? I've never understood what the alternative is."