Inverse ETF's - Short Selling
The Dynamic Wealth Report
January 28, 2008
An Important Signal for the Markets
When asked how to make money in the markets most brokers reply with the
famous Wall Street saying, “Buy low and sell high.” This is always easier said than done. Anyone can make money when the markets are moving
up and up and up. But, what if the market starts falling?
As we mentioned in Friday’s article, “Is
Your Portfolio Ready for a Recession?”
the 200 day moving average on the S&P 500 turned negative for the first
time in years. So the question is, “Why is this important?”
As an investor you should be watching this indicator closely. The
indicator simply takes all of the closing prices over the last 200 days
and calculates an average. The next day you add the new closing price
and drop off the oldest price. The result is a smooth line showing the
general trend in the market.
Look at this chart of the S&P 500:
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The blue line is the 200 day moving average. Notice how it has just
started to turn negative? The last time this happened was October of
2000, a time that the index was trading around 1400. Just 2 years later,
the market had fallen to around 800, a drop of 42%.
This indicator is watched closely by many professional investors, so
it’s not to be dismissed. Oftentimes professional investors will see
this change in trend and profit by shorting the market. For individual
investors shorting can be difficult to do.
To short stocks you need to be approved for margin trading by your
brokerage firm. This often requires large amounts of cash and
securities in your account. Some firms also require previous trading
experience. At the very least you’ll need to fill out a great deal of
paperwork.
To short you need to borrow stock from someone who owns it. Sometimes
the stock just isn’t available to borrow. If you are able to borrow the
stock, you immediately sell it in the market. This short position is what
allows you to profit as the price falls.
Shorting stocks is considered risky, as your potential loss is
unlimited. You might even lose more money than you
originally invested. With all of these challenges and risks it’s not
surprising that most individual investors don’t short stocks.
So how can we profit from a falling market?
Recently a new type of fund has been established called inverse ETFs. These funds are
designed to move inversely to specific market indexes. In other words,
if the market index moves down, the fund moves up. These funds also
eliminate the risk of losing more than your original investment. Your
total risk is limited to the amount of money you invest.
A number of them are available on different indexes. One of the largest is the
Proshares
Short S&P 500 (SH). It allows you to “short” the entire S&P 500 index by
buying a single ETF. You buy it just like a stock. By eliminating
paperwork, margin issues, some risk, and improving tradability, these
funds make shorting the markets easy for the individual investor.
I keep looking at the 200 day moving average turning negative. It makes
me think that now might be a good time to hedge parts of your portfolio
with these inverse ETFs.
• Residential Construction (Up 23%)
Over the last 10 days residential construction stocks have rallied
almost 23%. All of the industry news has been horrible. Home prices are
declining and new home sales numbers are falling at record rates. Can
anyone say “dead cat bounce”?
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