How to profit from a stock market crash
Posted on 30 September 2011 with 3 comments from readers
Every time there is a major stock market crash there is always somebody who successfully shorts the market and walks away with a fortune at a time when most investors are losing their shirts.
The ArabianMoney investment newsletter this month has some interesting ideas about how to use bear market ETFs to leverage into this downside event. For full details of the investment instruments used in this bear market ETF portfolio you need to be a subscriber (click here).
Bear ETFs
In principle this investment is easy enough. Bear market or short ETFs are exchange traded funds that short a major stock market index by replicating a short position in these stocks, so it will go up when this index goes down. This is precisely what a hedge fund will do as markets tank.
However, it is very difficult to achieve as an individual. For one thing the timing of short positions is very difficult to do successfully unless you spend your days at a trading desk and then still a matter of considerable experience and judgement.
With a short ETF you get this sort of exposure without the day-to-day hassle. There is another advantage in that these ETFs compound on a daily basis. With traditional shorting your upside is only ever a maximum of 100 per cent but with compounding ETFs there is no limit if markets really collapse.
Hedging falls
That said short ETFs naturally work equally quickly against you if markets surge and this does represent a considerable risk. But a small short ETF position in a portfolio to protect against downside risk in portfolio long in stocks is an excellent hedge. It does not have to be used with a gain in mind.
Last month subscribers to Clive Maund’s gold newsletter were advised to use bear gold ETFs to short the market and walked away with a fortune when the gold price crashed. This demonstrated that the exaggerated fears about the third party risk of using these instruments is nonsense. They do work brilliantly in the right circumstances.
Of course if you sit holding these ETFs for months and months as a market sinks so will your investment. But if you think the stock market is ripe for a major shake-out this is the place to be and will doubtless be widely discussed after the event!
3 Comments posted by readers:
The head of the Economic Cycle Research Institute said on CNBC TV Friday morning that the USA is going into a RECESION. No doubt about it. He can’t say how bad it will be, but said any shock will make it very severe.
Peter – have you considered the counterparty risk in some of these ETFs ? Even with the collateralised ones ? BAC and Citi are 2 of the counterparties for ETFS securities…….
The major corrections in 2007 and 2008 were predicted by some market analysts including myself.
As mentioned previously on my blog, the S&P 500 index big picture is bearish and despite market intervention the March 2009 lows unfortunately will be breached.
My long term indicators have continued to warn of US Dollar strength and EURO weakness and these signals have increased since 2009. The overdue dollar rally should be substantial.
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