Investing In Tough Markets

If you like following the stock markets, the last few weeks have provided quite the entertainment. Between still another investment bank failure, lower housing prices and rising commodity prices, its been tough to make money in this market. While its easy to say go long or go short, the violent price swings in the markets made it downright frustrating trying to make a few dollars. Shares would move up 1%, then down 1.5% then rocket back up again - all in the same day.

So what is an investor to do?

It doesn’t matter if you trade penny stocks, look for a “safe” mutual fund at the mutual fund store, or are just looking to protect your capital, you need a plan.

There are really 3 choices in front of you. Depending on the depth of your pockets, how long until you’ll need the money and the degree of risk, one of these situations will fit you perfectly. However, there is a cost.

First choice: Go long…

The markets have always gone up. Sometimes, it just takes a little longer. And sometimes, it you will hit major lows before making newer highs. It all depends on perspective. If you bought shares in some high flyers during the late 1990’s and held, you’re probably still in a loss position. If you bought in 1995, you’re probably still sitting pretty, despite the very high levels of 2000. Will this time be different? Who knows. When the stock market crashed in 1929, it took over 15 years to get back to that level. If you have time on your side, going long works.

Second choice: Go short…

We’re in a bear market. Don’t confuse a move up with the end of a bear market. Most often, its just a signal to go short again. I like ETF’s like DXD, QID and SDS, since they allow me to go short, by going long since they act inversely to the market they are following. Keep in mind that they are designed to provide twice the inverse return of the markets they are following. If the Dow Jones moves lower by 1%, DXD will move higher by about 2%. Conversely, if the Dow moves up by 1%, this etf will move lower by 2%. Its not out of the question to see these ETFs move direction by 5-10% a week. Great if you’re in position when the trend is moving higher, catastrophic if the market is moving lower.

On other thing to keep in mind about ETFs: You can lose money, even when you break even. For example, lets say DXD moves down by 10% this week, and recovers 10% the following week. You would think you’d be even. You’d be wrong. If DXD is trading at $100, and loses 10% of its value, its worth $90. When it moves up by 10%, it moves to $99 - 1% short of break even.

Your third choice: Keep your cash

Yeah, its not as sexy and thrilling as trading, but right now, its the smartest thing you can do. The stock market will be around for awhile. Its better to keep the powder dry and when the market gains some footing, you’ll be ready to make like a bandit. Remember, we wont hit a bottom, until everyone gives up on the stock market. Without capitulation, we’ll see many more bear traps. Play it smart, and be ready to pounce when the time is right.