Thursday, October 2, 2008

When to Exit Your Short ETF Positions

I was planning on discussing long index strategies for when the market turns around, but looking at today's dramatic declines, I decided to focus on short ETFs instead. At the beginning of July* we noted that the VIX had risen above 25 into bear market territory and suggested some of the more compelling short and ultra-short (ultra-short means double the return as well as the risk) ETFs that stood to profit most from the anticipated market decline. If you had bought some of these, you'd be whistlin' Dixie today as they are all trading well into the green. Many of them are up dramatically with roughly half of them gaining over 7%. Wow! The dozen that were mentioned in the July blogs are all up 7-18% today, including the SMN, the ultra-short materials ETF which is leading the pack just ahead of the DUG, the ultra-short oil & gas ETF.

The ultra-short ETFs aren't the only ones leaping higher. The VIX also took a 15% jump and is looking to go higher. Yep, you know what that means--a market bottom is a ways away. The Dow Transports, the DTX, is rapidly closing in on major support at 415. If it breaks that, then look for the index to fall to its next support level around 385. I'm focusing on the Transports because historically it's been a leading indicator of market direction, although it's not infallible.

Okay. Supposing the Transports break current support, what should you do? Risk-takers can buy more of the ultra-shorts. If you already own them, I'd recommend hanging onto them until you see a huge topping tail on the daily chart of the VIX. If we don't get that, then wait for the Transports to turn around and the VIX to fall below 35. Sure, today's action was dramatic. Traditionally, dramatic price movements tend to be an early indicator that the end is looming as investor fear is accelerating. My crystal ball has been on the fritz so I can't exactly tell you when we'll see capitulation, but when we do I think it's going to come fast and hard. This is why I want to put you on alert to begin dumping your short positions. As reggae-meister Jimmy Cliff said, “The harder they come, the harder they fall,” and I don't want you left watching a great profit turn into a mediocre return or—heaven forbid!--a loss 'cause this can easily happen especially with ultra-short funds.

So what should you do if you can't watch the market all day long? Set stop-losses!--be it a trailing stop, one based on support/resistance levels, or one based on other technical indicators such as the popular parabolic SAR. Whatever your choice of weapon, draw it now. Procrastinators will be punished!

*See following blogs for more on short and ultra-short ETFs: September 9, July 1, and July 2.

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