Play the Bounce to Hedge Your Longs

Okay, so the Dow was up 400 points Tuesday and one might be tempted to forget the feeling of doom and gloom Monday when it fell 778 points. But rest assured, the market has not bottomed. There is plenty of uncertainty, and equity markets are, for the time being, at the mercy of the US government.

I have been investing in equities for over 10 years, and this is one of those few times when I believe absolutely nobody knows which way the market will go tomorrow. If they say they do, they are lying. Unless you can predict what the bail out package will be, and whether it will be approved or not, you cannot bet on the market one way or another.

So what do individual investors do in this environment? Panic selling is not the answer. If it were a different time and place, I would recommend loading up on Apple (AAPL) at $100 and Google (GOOG) at $400. I would recommend picking up RIMM at $60, US Steel (X) at $70 and AIG under $3. Unfortunately, I can't recommend opening any long positions here, especially since it was an up day for the market and Wednesday may well be another triple digit down day.

So, if you haven't sold some of your longs Tuesday or on the way down these past few weeks, take some off the table. Otherwise, the best way to play this market is to buy some short ETFs. SDS, EEV or DOG are some good plays that are down nicely today after yesterday's huge gains. I would buy those to hedge your portfolio against another big down day. Remember, some pundits are predicting the Dow to fall another 1000-2000 points. If that happens (and I am not saying it will), you will need this hedge.

Comments

[oldman:]

it's tough to try and buy anything with large gap opens, whether up or down.

2008 Sep 30 09:43 PM

[fatcat:]

Faisal,you are still young...I have been trading for over 35yrs and I agree with your assessment.SDS calls have kept me alive in this market all year...even so,still down a bunch..

2008 Sep 30 09:49 PM

[Leif Peterson:]

Very good points. SKF, SCC, DOG, REW, etc. are good options. A pattern that has emerged is when 1/5th to 1/4 of your portfolio is inverse ETFs, it can balance the downside from having growth stocks. However, during the current crisis you will need to keep 4/5 of your wealth in treasury-only (bond) funds which are the lowest risk investment in the market. Check out Capital's CPFXX, or Fidelity's FDLXX, and Ishares Lehman TIP. TIP has actually weathered the storm quite well over the last few weeks.

By now we have heard it all: stay long, go short, don't panic sell, or "the US markets have a history of surviving incredible corrections/bubbles" so just ride out the storm. Some groups that are so bent on fundamentals expect you to assume that good fundamentals attract money -- so just hang on and every will be fine. Unfortunately, most of the (irreversible) damage regarding toxic money has already been done, and it appears that we will need to brace ourselves for the ensuing shock wave. In business, variation (variance) means risk, so if you think the 400 point rebound today following yesterday's correction of 700 points are good news, then you need to expand your horizons. Daily volatility bouncing plus/minus 150, 300, 450, 700 is a telltale sign of huge market instability -- like a wire cable that's getting ready to snap.

The political side of the equation is not good either. Have you realized that Congress now has Executive Branch (which includes the Fed and Treasury) in a stranglehold? All Gov't expenditures have to be approved by Congress, so until that happens, we are far from any bailout approvals. Last, a bailout would have nothing to do with the ideology of having free markets -- since a true free market will let the bankrupt and poorly run businesses die out.

Finally, financial debt now exceeds 41 trillion, and this is why the skimpy 0.7 trillion (700 billion) bailout is a band aid fix. Throwing money at the problems plaguing Wall Street is not the solution, instead, fundamental changes need to be made. Transparency has a lot to do with it. Specifically, increased transparency is needed for the gold carry trade, where central banks loan bullion every day to bullion banks, who list it for sale in the London bullion market -- this only serves to keep the price of gold down. Problem is, the actual listing is duplicative, so the same gold bullion can be listed for sale and listed in storage by multiple banks on the same day. No one knows what goes on here except for the central banks, bullion banks, and IMF. Supposedly, IMF is going public at the end of 2008 -- and this is in part what some of the gold bugs who expect 2000 are hedging on.

2008 Sep 30 10:35 PM

[nycDem:]

I've had about 1/4 of my portfolio(s) hedged form time to time in shorts (generally puts). While this has mitigated the downside somewhat, I've still gotten whacked.

I don't know how people who are all long are doing. Not well, I guess. This market sucks. It's made me a better trader...but I'd rather invest in fundamentals.

2008 Sep 30 11:03 PM

[peterthepai...:]

fat lady aint sung yet by a long way...regards the bailout i put market ticker's video on my site..take a look and ring your congressperson.p

2008 Oct 01 06:20 AM

[ken wender:]

when the bailout is passed the market will focus on earnings and the economy. Look out below.

2008 Oct 01 11:18 AM

[optionsgirl:]

I have qid, which is 2x inverse of NASDAQ. I would like to understand, though, how the short indexes will do if the SEC continues to add companies to the "no short" list and extends it through the election. Any views on this?

2008 Oct 01 11:50 AM

[techbull:]

How will the rescue package effect EEV? I'm thinking about getting into it but at this point I'm not sure. Can anyone help answer this? Thanks.

2008 Oct 01 12:13 PM

[artrogish:]

EEV is the double inverse of emerging markets. As money is pulled out of foreign markets this fund will rise. Specifically, the BRIC stocks are are falling, especially in Russia.
Bear market funds like QID use investments that are inverse to the stock. These funds seem to know how to deal with the short sale restrictions. Most short restrictions are for financial companies, so I would not be concerned about this when selecting a bear market ETF, unless you are looking at a financial sector ETF. I bought EEV and SMN on 10/1 and am very happy with the posative returns. I expect a long term bear, probably through Q2 in June 09.

2008 Oct 07 10:42 AM