Best Downside Protection for Amatuer Short Sellers
Contrarian, Macro, Emerging Markets
Seeking Alpha Analyst Since 2010
Nicholas Pardini is the founder of Davos Macro Research, which is a specialty macro research platform.
Davos Macro Research Company Website:
http://davosig.com
Nick has been invited and speaks at investment conferences globally and has appeared on financial media such Seeking Alpha, Zero Hedge, Futures Magazine, and USA Today among others. In addition to his financial publications, he runs the Youtube channel, Analyzing Finance with Nick
Previously, he worked as analyst on the buyside for eight years. He has developed an expertise in global macro trading, commodities, options markets, and equity analysis in the US and emerging markets. Nick has visited and lived over 43 countries in five continents to develop an understanding on how the world and markets operate from a direct perspective. He also speaks at investment conferences globally and has appeared on financial media such Seeking Alpha, Zero Hedge, Futures Magazine, and USA Today among others.
Based on the free fall of the market on Monday, the trend is clear. With technical indicators such as the MACD, relative strength, and a double top chart trending negative indicate an overbought market. Fundamentally, the picture is not much better. Inflation is now at an over 4% annual pace while wages and employment numbers fail to catch up. Also, severely high levels of government debt and downgrade risks will stifle any significant economic recovery. Whether the recent downturn a short term pullback or long term bear market, investors need to protect themselves against severe losses caused by remaining long. The best way to do this for those who are not experts in short selling is to short major indexes such as the Dow, S&P 500, Russell 2000, other major global indexes based on your risk capacity.
Short selling individual stocks can be more complicated that going long due to a variety of factors. First, the downside risk is infinite versus simply the price of the stock. Second, short trades can often defy fundamentals longer than expected. Several investors have lost fortunes shorting tech stocks and REITs during the dot com and during housing bubbles by simply being too early. Third, weaker quality stocks also tend to rally the fastest due to short squeezes caused by institutional covering. Unless you are a skilled at short selling or have some sort of insight of the company that increases your odds of success, you are better off with the indexes which provide the reward of capturing a down market at a lower risk.
Here is a list of some of the ETFs that short major indexes:
S&P 500: Buy SH, or short SPY
The S&P is probably the least risky market index to short due to its diversification of large cap stocks .
Dow Jones: DOG
The Dow moves similarly to the S&P except it less diversified with only 30 stocks. You are probably better off with shorting the S&P.
NASDAQ: PSQ
The NASDAQ is more tech focused and more volatile than the S&P. I believe that tech stocks and basic materials have the move long term growth of any sectors in the market, but it has held relative strength over the S&P since the dot com crash (even outperformed S&P during 2008).
Russell 2000: RWM
Shorting the Russell 2000 is a good way to gain a higher return that the S&P 500 from a shorting the market without taking on leverage. The Russell's downside volatility is significantly higher due its composition of small cap stocks. However, make sure to keep a tight stop or keep regular track of the index, because it will rally quickly once things turn around.
Emerging Markets: EUM
For bears on emerging markets, this is the way to go. However, emerging markets lack the fundamental weaknesses of the US, Europe, or Japan. Most of the pullback in this sector is caused by foreign investors panicking and selling their holdings for something else perceived to be more safe.
Levered Index Shorts: SJF, SDS, DXD, QID
The levered indexes are tricky because they have built in depreciation like the TBT and require big moves in a quick period of time to pay off. Use these for only short term trades, or if you are willing to take a lot of risk as these double or triple the volatility of the market as a whole.
Disclosure: I am long RWM.
Additional disclosure: I am short SPY and receive no compensation to write about this stock, sector, or theme.
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