Concerned About the Market? Here's a Good Way to Hedge

Includes: DOG, QID, SKF
by: Mike Rabe

Daily CNBC headlines are sounding awfully bearish these days. And when Nouriel Roubini, aka Dr. Doom, is all over the media firing his latest warning shots about the markets, you know bearish sentiment has returned.

The bearish tone among the analysts range from the mild (brief market correction) to the extreme (we're headed for a double dip recession). So how does one play this volatile market?

If you are concerned about the May correction, and you have fresh memories of the market crash of 2008, here's a couple options you might consider:

1) Remember that cash is a position. You should always keep some cash on the sidelines in case the markets do take an unexpected turn south. Avoiding a major haircut in the market is one of the key ways to beating the market. If a tsunami is coming, it is usually a good idea to get out of its path.

Another reason to keep investment cash on the sidelines is in case a great buy opportunity comes about - such as a new stock that you hadn't previously known about, or a stock you have on a watch list suddenly gets ridiculously oversold.

So always remember - cash is a position, and a very valuable one. Always keep an ace up your sleeve. Your ace is available investment cash at hand.

2) If you are convinced the major indexes are going to take a turn for the worse and possibly approach bear territory and you don't want to sell some of your current positions and be on the sidelines, consider a good hedge.

Three classic bear ETFs you might consider are:

  1. The ProShares UltraShort QQQ (ETF) (NYSE:QID)
  2. The ProShares Short Dow30 (ETF) (NYSE:DOG),
  3. and
  4. ProShares UltraShort Financials (ETF) (NYSE:SKF)

These classic bear ETFs scrapped near or at their 52 week lows in early April. And it is not a coincidence that the major indexes peaked in late April. Think of these bear ETFs as the inverse of the major indexes. If the major indexes rocket up, these bear ETFs will go down in price. And vice versa - if the major indexes get hit hard (as we've seen in recent weeks), the bear ETFs will see nice gains.

I personally prefer the ProShares UltraShort QQQ ((ETF)) (NYSE: QID) and the ProShares UltraShort Financials ((ETF)) (NYSE: SKF) for my hedge plays. If I think there is a good chance the major indexes are heading south but I don't want to sell off all my current positions, I will hedge with the QID or the SKF. This has worked in the previous couple weeks, and it worked beautifully in October 2007 and September 2008 when the markets were headed for major declines.

So keep these options in mind. There is always a way to make money in the market, regardless of which direction the major indexes are headed.

Disclosure: Author holds a long position in SKF