I have said many times that Market Direction remains the most important aspect of investing. If you can follow the market direction trend then in most cases you are going to profit or at least not lose capital. But if you want to bet against market direction then I hope you do well. Recently I have received a large number of emails from investors who are losing capital based on their method of market direction investing. It is impossible for me to answer all the emails and some I have dashed off an idea or two privately, but I thought this email from an investor would assist other readers in their own investing endeavors. The only way to become a better investor is to learn from mistakes and not repeat those mistakes. I prefer learning from the mistakes of other investors since I do not lose my capital and I can benefit from not repeating their mistakes.
I have broken this article into two parts. The first part will look at the mistakes these Investors made so we can all learn not to repeat them. The second part will look at possible ideas for rescue.
To that end let’s review this email from an investor who is holding HDGE Active Bear ETF and see what we can learn from their mistakes.
HDGE Active Bear ETF Concerns
I have combined their emails into one as their questions and tone of urgency were basically the same. I have made my additions to this reader’s email in blue to accommodate many of the other investors who have written me.
Teddi, I (we) need real help, real fast. I (we) am holding HDGE having bought it in May (15 at $23.60); (May 18 at $24.75); (June 5 at $25.20); (June 25 at $24.58) (many more around the same strikes) and I (we) am bleeding capital like crazy. How can I (we) rescue myself and end this nightmare? The market keeps going higher and it just shouldn’t! Everything is terrible. The media is filled with bad economic news. I live in San Francisco and half of my friends are unemployed. Have you seen the price of gas here in California. This is crazy, but stocks just keep going up. I wrote you today (Friday Sept 14) because HDGE fell another 1.5%! I am getting hammered. I am down 25% since June. Can you help?
HDGE Active Bear Market ETF
The investors who wrote in, all bought at the wrong time. Most are now down 20% to 25% as market direction continues higher. HDGE Active Bear ETF although a managed bear fund works primarily opposite to the market direction. When market direction is up, most bear funds pull back. When market direction is down most bear funds increase in value. So bear funds work like this: market direction up – they go down; market direction down, they go up.
Some bear ETFs are double the value of the move up or down.
Before looking to see what kind of rescue strategies might be applied, here are the top 8 lessons I learned about their investments in a Bear ETF.
Lesson 1: STOP-LOSS USE
The first thing to learn is that a stop-loss would have assisted them greatly. A stop-loss would have held their losses to whatever percentage they were willing to accept. A good stop-loss might be at 6%. When market direction moved against them, they would have been stopped out after losing 6% of their value. A 6% loss can be easily recovered. A 25% loss is more difficult depending on how much capital is involved. Some of the readers who wrote me have a lot of capital in their trades in HDGE Active Bear ETF. Recovering 25% of an entire portfolio is very difficult to do.
Lesson 2: PROTECTION THROUGH COVERED CALLS
Another method When betting against the market direction is to have considered some type of protection. They could have protected themselves through staggered covered calls right from the outset. For example when the above reader whom I will refer to as Bill, bought in at $25.20, he could have sold covered calls starting in the money possibly at $21.00 all the way to $28.00 depending on the number of shares he bought. If he had 2000 shares then he could have broken the trade up in a fashion similar to my The Gambler Strategy in which he could have left perhaps 500 shares without covered calls and then taken the remaining 1500 shares and sold 15 covered call contracts but spread them out at varying call strikes and even varying months. For example:
3 contracts for July at $28.00
3 contracts for August at $25.00 (at the money)
3 contracts for Sept at $24 (slight in the money)
3 contracts for Sept at $22 ( in the money)
3 contracts for Jan at $20 (deep in the money)
This leaves 500 shares free and clear of covered calls so if the market direction had fallen further those 500 shares would have continued to appreciate in value. (Remember a bear ETF works opposite of market direction; market direction up – bear etf down; market direction down bear etf up) As per The Gambler Strategy, they could also be used to rescue shares that had covered calls sold in the money and now the decision was to try to buy back those calls and have those once in the money covered calls shares, appreciate further in value.
Effectively by using a staggered covered call strategy and setting up a variety of strikes an investor is hedging his Hedge Active Bear ETF (HDGE). The tools in The Gambler Strategy describe this better but with a bear ETF it is important to understand that the tools in The Gambler Strategy for timing buying and selling of the sold options cannot be applied to the bear ETF but must be applied to the SPX or S&P 500 index itself since HDGE Active Bear ETF is basically a managed bear fund that seeks to appreciate in value from falling stocks which normally equates to a fall in market direction.
Lesson 3: REALIZE YOU ARE NOT IN A BEAR MARKET
This is probably one of the most important aspects of timing when to buy a bear ETF like HDGE. While you will certainly make money if you have timed getting into a bear ETF such as HDGE Active Bear ETF at the start of a market direction pullback, you need to realize what kind of stock market you are in. If in April when for example, the Trader’s Almanac had advised its members to get out of the market or at least to buy into a bear fund like HDGE Active Bear ETF, the fund was trading at around $21.50.
At $21.50 there was lots of time to hold HDGE and pick your point to sell. If for example by the end of May an investor had sold his HDGE ETF, it was trading around $25.20 which was a very nice return of about 17%. If an investor had used a stop-loss and kept moving it up as HDGE ETF increased in value, they may have been taken out in June perhaps around $24.75, still a nice return. The point being that those investors who bought when the market direction was near its high and indications were for a market direction pullback, then instead of losses an investor had plenty of time to profit.
But this was not the case with the above investors who bought as the market direction pulled back almost 10%. In other words they bought as the market correction bottomed. A better choice would have been to establish a percentage of decline when to buy in. For example, perhaps a 5% decline in the overall market would mean buy HDGE Active Bear ETF or such similar product and be sure to use a stop-loss in case the decline ended there. Instead the above investors bought near the bottom of a decline, obviously believing that the decline which was starting to reach 8% or 9% by the time they bought in was going to get worse. Again a stop-loss would have saved them from steeper losses.
Understanding that bull markets can have severe corrections of up to 10% can go a long way to protecting investors from making mistakes like buying HDGE at the wrong times.
Lesson 4: DON’T HOLD A BEAR ETF, TRADE IT
Another mistake was buying and holding HDGE Active Bear ETF. I trade the SPY Puts for those periods of weakness. I can never be sure that a large market decline is going to happen. However I can benefit from trading the SPY PUT daily on signs of weakness. While I will miss the profits made by buying at the start of a correction and selling right at the bottom of the correction, I don’t know any investors who can do that anyway. Therefore I developed my SPY PUT Hedge to benefit from daily weakness and nothing more. Still though the returns from even trading the SPY PUT on signs of daily weakness adds up quickly. In the 2008 market collapse my SPY PUT Hedge protected my entire portfolio to 68%. This was a terrific return all done through day trading the SPY PUT.
By Buying and selling the HDGE or any active bear fund, you are in and out of the fund making small profits that can add up to bigger profits, but when the market turns the wrong way you are either out or you sell out for small losses. Those losses do not wipe out all the gains made from all the previous trades. This is the importance of the cash cushion I talk about with my SPY PUT trades. The cash cushion keeps growing with each successful hedge trade. It then helps to cover those days when the hedge trade fails and there are losses.
Lesson 5: DON’T BET AGAINST THE MARKET TREND
I have said this repeatedly. No matter what you BELIEVE should happen To market direction, don’t bet against the market direction trend. This article on Not Betting Against The Market Direction Trend discusses this in detail. When you read about an investor who cleaned up in a market crash recall that the investor make a gamble. They took a large risk that they were going to be right. Now consider how many investors tell you about losing money betting against the market trend. It’s like Vegas. All my friends tell me how much money they make when they go to Vegas. They never lose money in Vegas. A few years ago I went on a trip to Vegas with our local investor group and at the end of the week it seemed like I was the only one who lost money. But I was also the only one who seemed to have cash for shows, a trip to Hoover Dam, a helicopter ride and I paid cash for my hotel stay. On the way back home I loaned cash to about 25 of our local investor group to buy incidentals. How much money did they make?
Lesson 6: FORGET THE MEDIA
Do not listen to the media. The media loves doom and gloom. When was the last time you read about all the pension funds that have had their lost profits restored from the 2008 market crash? Read about that lately? But when was the last time you read how George Soros says the Euro is doomed, or Roubini has said that the worst of the credit crisis is yet to come, or how about the Madoff Ponzi scheme which I still read about every so many days. Forget the media hype. Instead look at the market technical indicators and consider what they are telling you. Never throughout this entire correction did the market technical indicators show a crash was impending. Indeed starting the second week of June, the market exhibited lower highs and lower lows, a clear technical indicator advising that the market direction was shifting to up. This was around the time so many of the readers who wrote me were busy buying into HDGE Active Bear Fund. They are buying without looking at the market timing technical indicators.
Lesson 7: KNOW YOUR LOSSES AT THE OUTSET OF THE TRADE
When buying into any bear hedge fund you need to understand that without a stop-loss your losses can be large. Instead of buying a bear ETF, consider that when you buy SPY PUTS you know the minute you buy what your entire losses can be if you are wrong and never close your trade. For example on July 12 I bought 10 SPY PUT Contracts with an expiry of August 8 at the $133 Put strike. The total amount of capital at risk was $2389.50. If I had held those right through to options expiry in August my total loss would have been $2389.50. So when buying protection consider buying protection that has defined losses already built-in.
Lesson 8: NEVER COMMIT MORE CAPITAL TO A SINGLE TRADE THEN YOU CAN AFFORD TO LOSE
The percentages of total capital some of the investors invested, shocked me. It was obvious to me they were trying to “clean-up” in one big trade on a market direction gamble. I presently have over $100,000 invested in Intel Stock. I can afford to lose it. I have $210,000 in YUM Stock. I can afford to lose it. If you cannot afford to lose your capital, then don’t invest it in risky assets.
Those are the top 8 lessons I learned from their mistakes from investing in a Bear ETF. Did you learn more? If you did please add what you learned in the comments section below. I would love to hear from you.