Many investors are fearful of short selling, but shouldn’t be. The path to profits are just as easily obtained on a falling security as they are on a rising security. In recent years, securities firms have created ETFsthat you can buy that give you a short position in various indexes. These are quick and easy ways to short securities that can help hedge your portfolio during what appears to be a likely bear market.
During bear markets, the overall trend for stocks is down as opposed to up. There are many ways people define bear markets in addition, but the ones I prefer have mostly to do with technical analysis as confirmation. I never really use technical analysis in investing, but more as a windsock.
What we’re seeing is almost every index rolling over to the point where the 200-day moving average crosses below the 50-day moving average. This essentially means that the index is now in a downtrend that will be difficult to break.
Thus, I’ve been hedging my portfolio with ETF shorts. Here are some options for you.
Bear Market Strategy: Short the S&P 500
Opening a short position against the 500 largest stocks by market cap is a good basic play. That actually allows you to cheer when the market goes down. The ProShares Short S&P 500 (NYSE: SH)was a natural first stop because I saw earnings revisions for the coming year were being reduced. Stock prices follow earnings, so if earnings are slowing, P/E ratios will contract. Since the index was already overvalued compared to its historical mean, the logical step was to short the index.
By the way, there’s a lot of financial engineering in these stocks. Companies buy back stock to push EPS up, hoping investors ignore bottom-line net income numbers.
If you are aggressive, you can double up on that position by using leveraged short ETFs. ProShares UltraShort S&P 500 (NYSEArca: SDS) gives you twice the movement of the S&P 500.
Bear Market Strategy: Short the Nasdaq 100
The market has another quirk in that tech stocks tend to be more volatile than other sectors. Thus, the Nasdaq 100 is an index that may experience more volatilitiy to the downside than other sectors.
The ProShares Short QQQ (NYSEArca: PSQ) allows you to short this index. What’s particularly intriguing about this play is that many of the Nasdaq 100’s top stocks are some of the momentum names you hear about every day. Those names, especially ones that have weak revenue and earnings, can be especially whacked during down times as investors rush to remove risk from their portfolios.
In some ways, this is a more aggressive and more narrow short play than the S&P.
Bear Market Strategy: Short the Russell 2000
Most people focus on big names. However, small companies can have more exposure to declines because they are less mature, and haven’t had the history to build up a big cash-heavy balance sheet. They likely have more debt to service, and if a recession is part of the bear market, that debt may become a challenge to service.
History shows that the Russell 2000 generally outperforms its larger cap brethren on both the up and down sides. Since the Russell 2000 hit its high last year, it is down 22%. The S&P 500 is only down 12%.
The ProShares Short Russell 2000 (NYSEArca: RWM) is the security to short the index.