Recipe for a Downtrend: Reduce Equities, Keep Some Cash and Hedge

When the market is in a downtrend it makes sense to balance not only your stocks by sector, but the amount of cash you have and the amount of hedging in your account. I am currently 25% in cash and 25% hedged with Dow Jones 30 Inverse by Pro Shares (DOG) which matches the inverse of the Dow Jones 30 dollar for dollar.

I am not a big fan of the Ultrashort ETFs, as they provide too much movement when the market does have a rally of a couple of days or a week. These ETFs provide double the inverse of a particular index or sector. So when the Nasdaq rallies 4% over the course of three days like we saw recently, the Ultrashort QQQ (QID) would lose 8% of it’s value. That is too much movement if you’re not watching the market daily and/or have high commissions to pay when you move in and out of positions.

ProShares offers as many single inverse and they offer Ultrashort/double inverse ETFs. Here is a listing of all the single inverse ETFs that you can add to your portfolio to hedge against downside movement when the market is in a negative chart formation. Short QQQ (PSQ) and Short S&P 500 (SH) would be my recommendations after the Short Dow30 (DOG).

Disclosure: Author holds positions in the above-mentioned ETFs

Comments

[300mph:]

What difference does it make how much your short ETFs move relative to their related index or fund? Figure out how much protection you want and factor accordingly, it's simple arithmetic. If your buying single inverse then buy 1:1, if you are buying double inverse then buy 2:1 or half as much.

2008 Feb 19 05:00 PM

[Fed up:]

Good point. That's one of those "duh" moments.

2008 Feb 19 07:22 PM

[Steve Patte...:]

Within the article I initially mention my percentages of being in money and being in short positions. The single inverse index funds support those mentioned percentages.

2008 Mar 01 12:39 PM