Profitable Trading and Investing in a Bear Market: Not Just for Pros

Many times I have been in a discussion about markets with acquaintances in which I notice an odd look on their face when I start talking about profiting from downtrends as well as up trends. I suppose this is because of a bullish bias at retail brokerage houses that leads to the belief that uptrends are good and downtrends are bad.

In my view, good is not up or down. Good is an objective strategy for profiting from major price trends. Good is risk and money management procedures for keeping the inevitable loosing trades at a linear level, while allowing the winning trades and investments to become exponentially profitable. Good is cutting losses short and letting winners run. Good does not have to be up or down. Good is objectivity.

Every investor and trader has a fiduciary responsibility to himself or herself and family. The first line of action is getting out of the way of markets that have negated your investment hypothesis and therefore are causing losses. The next line of action is catching the waves that are profitable. Overvalued stock markets are not something that is good for the country, and investing blindly in them is foolish, not patriotic. Invest in these markets when they have become undervalued. You can participate actively or passively in ways that will result in your having more capital available for the rebuilding process after a recession or depression ends.

Before we get into the more proactive ways to benefit from major bear markets, we must realize the passive way of gaining value. Sitting in cash during major stock market downtrends is in itself a profitable venture. This is because the value of stocks that you can buy at a later date are losing value relative to the cash you are sitting on. Sitting on cash and liquidating stocks (real estate and other asset classes) when the market is trending down increases your net worth relative to the things that the cash can purchase. And, no, I did not just start preaching this.

I don't want to get too far off the original subject here, but even cash held does not have to be held in a bank. As we have seen, bank failures that are due to over-leverage and bad loans are not out of the realm of possibilities. Instead of using a bank or savings-and-loan, you could simply store your cash in short-term U.S. treasuries. Short-term U.S. treasuries should provide the most safety unless or until the currency is completely destroyed (likely in the long run, due to inflationary fiat monetary policy). For currency protection, have some physical gold too (real money). The easiest way to access short-term treasuries is through treasury only money market funds. You can also buy them directly from the treasury if you want. A money market fund (remember: we are suggesting treasury only, for safety) can even be used like a checking account, although without the debit card. I wanted to put this general information out there, because I often hear "well, do I just keep my money in the bank; sitting there!?" after being solicited as to my opinion of what to invest in right now. In a secular bear, we are primarily interested in wealth protection, while wealth perpetuation is the secondary focus. With all of this out of the way, perpetuation is what we are going to talk about now.

Never before has profiting from investments and trades geared towards declining markets been as accessible as it is today. We used to have to either sell stocks short, sell futures contracts, or buy put options in order to profit from a downtrend. None of these (with the exception of options, possibly) are as difficult or complicated as most people think. Regardless, none of this is currently necessary for the investor looking to profit from market downtrends.

Many different Exchange Traded Funds (ETFs) are now available. These allow you to invest in the movement of the indexes and sectors they are designed to track and follow. Some of these ETFs are even leveraged to twice the price action of the underlying index. Yes, you can sell the ETFs short, but you don't even need to do that anymore. There are inversely correlated ETFs. Inverse ETFs will go in the opposite direction from the price of the underlying index. For example, an ETF which is inversely correlated to the S&P 500 stock index will increase in value when the stock market declines. An ETF that is inversely correlated to the S&P 500 by a 2x multiple, will approach a price change of 200% more than 100% of the market decline in which the leveraged inverse ETF was held. When the markets bottom out, and we get a signal that the secular bear market is complete, you can even use the directly correlated ETFs to participate in the upside if you want.

Under the label "Trader and Investor Education" I have previously laid out some really simple technical trend identification and trend following approaches that can be applied to both long and short term time frames. A simple approach for using the ETFs would be to use trend rules and approaches we discussed, then pick the appropriate ETF for the directional trade or investment you want to make. Of course some of your trend signals will be wrong, leading to some of your trades and investments being wrong. The use of ETFs does not change the fact that we need to cut losses short and let winners run.

I personally think some of the most useful ETFs and Inverse (short) ETFs are found through ProShares: www.proshares.com. No, I don't make any money from the link. I just like their product offering. I've been more of a macro styled trader / investor over the years, so the funds that really catch my attention as potential trading and investing vehicles at the proshares site are:

SH: Short S&P 500
SSO: Ultra S&P 500
SDS: Ultra Short S&P 500
DOG: Short Dow 30
DXD: Ultra Short Dow 30
DDM: Ultra Dow 30
ULE: Ultra Euro
EUO: UltraShort Euro
YCL: Ultra Yen
YCS: UltraShort Yen
UGL: Ultra Gold
GLL: UltraShort Gold
AGQ: Ultra Silver
ZSL: UltraShort Silver

There are many more ETF's listed at the site, but these are the ones that caught my attention the most as potential vehicles for even the small and non-professional trader who wants to trade and invest in both the uptrends and downtrends of major macro markets.

There is no holy grail to trading or investing. Losses are inevitable, but can be limited with good money and risk mangement. Downtrends are as profitable (sometimes more) as uptrends. Hopefully knowledge that these vehicles exists will help anyone who has been watching their portfollo shrink while not getting any objective advice from the retal investment community.

As I have stated in previous posts, we currently view upside moves in the S&P 500 as bear market rallies, and would use them as selling opportunities within the paramaters of our directional, risk and money management rules. I am posting this during a multi-month rally in the S&P 500, hoping it to be useful to anyone who has found to much comfortable complacency in the hope that the current rally is the end to the secular bear. We don't think it is. If we are wrong, then following the price trend will eventually put us on the right side of the market. If we are right, then doing nothing will lead to the financial ruin of many.