Who Cares What the Market Does?

OUTSMART OBAMA AND RETIRE EARLY Gas prices are up 96.5%... Big oil had $93 billion in profits in 2013... And it's just getting started. We've uncovered an improbable energy development so you can outsmart Obama at his own game... And cash in big. Tuesday, October 21, 2014 | Issue #2400 Technical Tuesday: Who Cares What the Market Does? Christopher Rowe, Technical Strategist, The Oxford Club Confused about which direction the stock market is going? Don't sweat it! I have a solution you're going to love. Investors still make sizable profits in "market neutral" positions in the form of "pairs" positions. Many do it incorrectly, so let's go over a few examples to make sure you're on the right path. A pairs position is constructed using two separate positions as one. You buy one investment vehicle and sell short the exact same dollar amount of another investment vehicle. (When you sell short, you make money if the position declines and vice versa.) If the stock market declines by 50%, knocking down the position you bought as well as the one you sold short, you're profitable as long as the one you bought declined by less. When the strategy is used with two individual stocks, there's always the "company risk" like one company suddenly being acquired or being investigated by the SEC for accounting fraud. Exchange traded funds (ETFs) reduce that risk to a fraction because they represent a diversified basket of stocks. They are ideal since they allow exposure to various sectors, styles or asset classes. The Death of Cable TV In the months ahead, one company is going to "kill the industry as we know it." We call its radical new invention "NuCable" and it's going to change ALL of our lives. It's all set to go down... and early investors could easily TRIPLE their money! Position Size If your long position (the one you bought) advances by 35% and your short position advances by 20%, then your long position had a 15% outperformance. What if you bought $10,000 of one and sold short $10,000 of the other? You would have made 7.5% (minus trading expenses) because you lost $2,000 on one side and gained $3,500 on the other, and $1,500 is 7.5% of the total $20,000 invested. So to realize the entire outperformance as a profit you can use the same capital commitment of $20,000 to take a $40,000 position. How? Margin allows investors to borrow from their broker. I can make a $40,000 investment as long as I have $20,000 cash in the account. Be sure to take margin interest rates into consideration and discuss with your broker whether a margin account is appropriate for you. The other consideration is that exchange traded funds represent a basket of stocks. So I'm comfortable having 80% of my entire stock portfolio invested in a single ETF representing the S&P 500, as it currently represents 504 stocks across 10 major sectors. What Not to Do Don't apply this strategy with two securities that aren't similar in some way. Avoid using two securities that have an inverse relationship because if one goes up while the other goes down, it's a double whammy of profits or losses. So, for instance, I wouldn't want to sell short the energy sector and go long on the U.S. dollar since the dollar puts inverse pressure on commodity prices in general. Also, make sure there isn't an enormous difference in volatility between the two positions. The idea here is to lean toward a market-neutral position, and if one security is simply more volatile than the other, it may go up by more in an up market or down by more in a down market. Pairs Trading Examples In the following examples, I'll illustrate the difference between two securities over the past six months by showing you the absolute outperformance as well as the relative strength chart of one security versus the other. The relative strength charts represent outperformance, so when it's advancing, the first security is outperforming the second and vice versa. SECTOR ETFs You may have noticed that biotech has been the strongest sector in 2014. You may have also seen how consumer discretionary (a.k.a. consumer cyclicals), which led the bull market until early this year, began underperforming every other sector in February. If you're like me and believe that recent trends are the best trends to invest in, you might have bought $10,000 worth of the iShares Nasdaq Biotechnology Index ETF (Nasdaq: IBB) and shorted $10,000 worth of the Consumer Discretionary SPDR ETF (NYSE: XLY). View larger image Over the past six months: The biotech ETF advanced by 19.66%, gaining $1,966. The consumer discretionary ETF advanced by 0.92%, which is a loss of $92. Remember, the strategy sold short XLY, so that side of the position lost money when XLY advanced. The net gain (not including expenses) is $1,874 (or 9.37%). (There's an 18.74 percentage difference, but cut that in half considering there are two $10,000 positions.) COUNTRY ETFs Perhaps you saw the weakness in the eurozone and realized that, for years, the U.S. equity market has been the single strongest asset class available to invest in. So you bought $10,000 worth of SPDR S&P 500 ETF Trust (NYSE: SPY) and sold short $10,000 worth of Vanguard European VIPERs (NYSE: VGK) View larger image Over the past six months: The S&P fund advanced by 2.08%, gaining $208. The eurozone fund declined by 10.64%, gaining $1,064, so this time the strategy won on both sides. The net gain is $1,272 (or 6.36%). STYLE ETFs You may have thought that the Russell 2000 small cap index would outperform the S&P 500 index after lagging for a month. So you bought $10,000 worth of iShares Russell 2000 Index ETF (NYSE: IWM) and you sold short $10,000 worth of SPDR S&P 500 ETF Trust (NYSE: SPY). You would have been wrong. Here's how that would have looked. View larger image Over the past six months: The small cap ETF declined by 4.19%, losing $419. The S&P fund advanced by 2.08%, losing $208, so this time the strategy lost on both sides since SPY was a short position. The net loss is $627 (or 3.14%). There's always a way to make money in the financial markets. And in a market like this, investors are told that they can make money only by investing in ways that make them uncomfortable. They think they have to be brave. But it's not true. With a strategy like this, you don't have to have a stock market stance. You can make money no matter what the market does. Good investing, Chris Click here to post a comment on InvestmentU.com Social Security's "Final Deathblow"? A coming $91 trillion market shock - lasting just 3 minutes - could gut our Social Security system once and for all. If you're at or near retirement age, you need to know what's coming. And there's still time to prepare. Here's the shocking truth, from America's most conservative income investor... including his recommendations for surviving the possible crisis. 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