Short-Sided Thinking

July 30, 2008
By seadmin

Making money in the market is not just a matter of buying a good stock, mutual fund or exchange-traded fund (ETF) and then watching it go higher. These days, you’re likely to have more success by investing on the short side of the equity ledger.

Now, when I talk about investing on the short side, I am not suggesting that you short stocks in the conventional manner. I do not want you to borrow shares of XYZ Corp. from your broker and then hope the stock goes down so you can replace them in the open market later for a profit. That’s the old-school method of shorting.

These days we are blessed with ETFs, and in recent years there’s been a growing number of inverse, or short, ETFs designed to move in the opposite direction of not only the major market indices, but also of specific market sectors.

The table below shows just how many great options you have to short this market with ETFs.

As you can see, the wider market decline certainly has been a boom to many of these inversely correlated ETFs. These funds are designed to move higher when their respective indexes move lower. But the funds in the list above don’t just move in concert with their respective indices.

The funds listed here are "Ultra" funds, which mean they move twice the inverse of their respective index. For example, the first fund listed here, the ProShares UltraShort QQQ (QID), moves twice the inverse of the NASDAQ 100 index. That means if the NASDAQ 100 falls 2%, QID will rise 4%.

In a tough market environment, one that’s constantly characterized by a consistent downtrend in equities, it behooves you to think about how to make money on the short side.

One note of caution here is that investing on the short side is not for the faint of heart, nor is it for the inexperienced investor. If you do want to buy some short ETFs, then I recommend that you employ the following rules:

1. Only use a small percentage of your overall investment portfolio to go short. Depending on your risk tolerance, you’ll want to keep your short ETF purchases to between 10-25% of your total investment capital. Please do not risk the bulk of your portfolio on short, leveraged ETFs.

2. Define your risk. When investing short, you must employ strict stop losses and you must always protect yourself from a short position going against you. We have seen a lot of volatility in these ultra-short sectors, and although the trend so far in 2008 has been conducive to these funds, it’s by no means a safe or easy way to make a dollar.

3. Cover your short positions when the market is going your way, and not when it decides to go against you. If you are short and the market is having a big down day, then that’s the day to sell your position. When you are short, you want to sell into strength, and strength in a short position is when the major market averages all are substantially lower.

If you’re looking to employ a little short-sided thinking in your portfolio, then I invite you to check out my ETF Trader advisory service.

Many of our most profitable moves have come in leveraged short ETFs, and if my thesis is correct about more downside before the energy runs out of this market storm, the short side of the ledger is where the big money is going to be made.

To find out more about short ETFs — and how to use them with my ETF Trader service, click here.

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