Turning Market Panic into an Advantage with ETFs
While the great majority of stock investors wrestle with the decision of how much to be in or out during these wild times, those more in the know instead see opportunities.
Exchange traded funds, or ETFs, have become enormously popular among investors over the last few years, and more and more money is put into them every year. ETFs allow investors to trade funds like they would a stock, allowing the revolution in trading stocks and other assets online to make it to the world of funds.
ETFs offer the same fast execution that trading stocks online provide, where the funds themselves trade on the secondary market like stocks do. You no longer have to place your order with your broker or advisor and then wait a day or longer for your orders to be sent to the market and filled, like is the case with mutual funds, as all it takes now is a click of a mouse.
This advantage is an even bigger one in times of great volatility such as today, and with markets moving as fast as have been, the lag time with mutual funds can add up to a big move against you, of several percent. This might be fine for those who refuse to manage their positions, but for those who do wish to choose when to enter and exit their trades, ETFs take fund trading from the pre-1970’s era that mutual funds are still stuck in, and update this trading to the cutting-edge technology of today.
ETF investors tend to be well aware of this advantage, and this is a big reason why so many investors prefer ETFs over mutual funds, but they probably have not envisioned this meaning as much as it has lately. There are two other big advantages that ETFs have over mutual funds that they may not be anywhere near as familiar with, which come out of the more flexible structure that ETFs enjoy.
The first is the ability of an ETF to be set up to go in either direction, long or short. If you see the stock market go down and want to speculate on it going down further for a while, like we are seeing with the market right now, you are no longer committed to the long side only where you either get out of stocks for a while or are forced to suffer the losses that come, as you can now bet on things going down as well as up.
These are called inverse ETFs, and are called this because the price moves inversely to the asset. If the price of an asset is declining, no longer do we have to trade futures or contracts for difference, or short individual stocks, to get in on this action, and these things are all very distant from what the great majority of investors would ever consider.
This sort of thing is generally limited to traders, those whose business it is to take advantage of shorter-term fluctuations in prices and seek to be on the side of momentum. While this can be a very lucrative way to make money from financial assets, it requires a great deal of skill and training to just get to the point where you can do this profitably at all, and most people who try this lose all of their money in short order.
We can certainly understand how the eyes of investors would bug out at the thought of trading their portfolios on such a timeframe full-time instead of seeking longer-term price appreciation on the long side, because as long as price is moving in the right direction, even the clueless tend to make a decent return, one enough to block out anything that you’d need to think about.
Most feel that betting on things going down is far too risky, a conclusion they reach by taking this strategy and imagining that they would be doing this over the long-term. This would be a simply terrible approach with stocks, since they go up on this timeframe and we’d just get creamed.
We never want to use an inverse strategy past the point where it makes sense to, and it only makes sense to be on the short side when the short side is winning. The long side may win in the end, but it does take some real breaks. In the meantime, when the bears are in control, the declines that they produce can put you in the hole if you are holding against the trend.
Since the trend has shifted during bearish periods, it should be obvious to us that the safer approach is to go with the tide rather than to swim against it. This is especially true during periods of very high volatility such as what we have seen during the coronavirus show, which is still playing 24 hours a day and is still placing a lot of downward pressure on stock prices.
The thought of a shorter-term position is enough to scare many investors, and when we add in going short and doing this during extreme volatility, and doing this with leverage, that’s going to appear like a horror show to them, at least at first glance. Just about everyone will stop at this first glance, but they need to be spending more time than this looking at these options, and ETFs are the vehicle that opens up all these possibilities to them, where they can get in on all this action from their regular brokerage accounts.
The strategies that we will be giving you are not intended for traders, even though traders will approach this in a similar way. Instead, this advice is meant for everyday investors, and all you need is an open mind and a minimum level of sensibility to pull these things off and seek better returns while also managing risk better than just holding stocks on the long side.
We need to not be put off by the fact that this goes so much against the grain, because we’re instead looking to go with the grain not against it, and the grain that guides just about all investors, flowing one way only and excluding any other strategy but the one that they are told by virtually everyone to follow runs against the grain of not belief, but reality.
We will look at four different types of investments here, stock indexes, bonds, gold, and oil and gas stocks. You could probably ask a random person on the street and they will tell you that stocks are running down hard, oil and gas stocks are running down even harder, gold is doing very well, and bonds are doing phenomenally well.
None of this is any secret or requires any real analysis beyond just looking at the performance of these asset types. Knowing what is going on and knowing what to do about it are two different things though, and we’re out to fill in the second part, how investors may not only protect themselves more but shoot for substantial profits during the coronavirus show instead of being willing to accept the losses that keep building.
To See What is Real, We Need to Be Willing to Set Aside our Illusions
The first thing we need to talk about is how we need to set aside our illusions of the benefits of diversification, and while we may still want to mix things up a bit, it’s actually preferable that we keep diversification to a minimum, and only use it to the extent it may help us manage present risk.
The diversification that investors usually seek are ones that seek to protect against future risk, with the assumption that we will refuse to help ourselves when these future risks come home to roost and will instead rely on what amounts to dilution. If we are worried about being exposed to excessive future price risk with our stocks, we will just choose to have a smaller percentage of our portfolio in stocks, and the rest in something else that doesn’t go down as much, such as bonds.
We also do this with types of stocks, perhaps owning less of the good ones which both go up more and go down more than lesser stocks do. Both of these strategies require that we promise to be helpless when the need for this arises and just become bystanders with our own investment money, and simply look to water down our results and lose less.
There are investors who are prancing around like peacocks boasting of their 3 or 4 percent losses over the last few weeks, where they have held a good portion of their assets in bonds which have really trimmed the losses from their stocks. Simply exiting their stocks and putting their money into bonds when this happens is not in their playbook though, even though a fairly bright child might have at least considered this if presented with the problem.
They may simply think that these are things that traders do, and with the majority of traders failing, they don’t wish to join them. The majority of traders are clueless though and this is not what we wish to see our investors even thinking about emulating. Trading every day is very challenging, and it takes several years of full-time trading to get good at this, not just a few bucks and a few simple but broken ideas that they rarely have the sense or courage to execute properly anyway.
Top traders are making a killing these days though, and trading right now is not only much more profitable than usual, it’s also a lot easier. Traders trade and benefit from trends, and the bigger and longer the trends, the better. The coronavirus scare has simply been a festival and of such a delightful magnitude that they may not see for a long time.
The bigger the moves, the easier they are to trade, even though this still requires a decent amount of sensibility as you do need to get out when the party ends and go back to your normal investing life if you wish. The moves that this is suitable for investors aren’t the normal ups and downs of the market but the big swings. They are simply huge now and this means that it’s time to go to the phone booth and put our trader capes on if we want to turn these times from very painful to very pleasurable.
Getting back to the diversity issue, you don’t need this in these times, as it won’t help you holding different stocks when they are all getting hammered. Holding any stock when it is getting hammered is evidence that we do not know what we are doing.
This also is not about how much you want to lose on stocks and how much you want to make with bonds, as not wanting to lose with stocks by bucking this big trend and wanting to make money from bonds when they are on fire is what we should we want instead, if we are sensible at all. Many are not, but we should at least make this a goal of ours.
We don’t want to be like those investors who are scared to death about their stock positions as they decline, but also scared not to be in them or to have their prescribed allotment of 60% stocks 40% bonds or whatever they have chosen. It is both amusing and sad that they would refuse to try to shelter themselves from this mess. However, they are just sheep, and solely rely on their shepherd’s staff to direct their every move.
The actual sheep do not sign up for any of this though, as they are held captive. Investing sheep volunteer. The animal sheep aren’t to blame here and get a bad rap, but the investing sheep well deserve this metaphor.
There is another misconception that serve to turn investors away from something like this, which is the idea that betting on things going down in the short-term is riskier. Nothing could be further from the case. Short positions can go against you just like long positions can, but those married to the long side are taking all the risk that the market wishes to throw at them, while short-term short positions are only in it for the money and go away when the money goes away and the risk against them even starts to show its ugly face.
With a Big Advantage Like This, We Want to Leverage It a Little
We also do not want to be afraid of using a little leverage, to the extent that ETFs allow, either 2X or 3X. We should be using 3X during these times as investors, although this is enough and more than that would require greater skills in managing the extra risk than may be expected from investors who are pure amateurs in this game. The amateurs can do extremely well when the water is moving this fast though.
The reason why we want to use this leveraging is that this opportunity is so substantial and reliable that our risk to return ratio, if we play it right, is so good. Opportunities like this do not come around very often and we want to cash in when we have such an extremely unusual advantage.
We mentioned stocks in general, oil sector stocks, bonds, and gold as the four types of investments that we will be discussing using ETFs for. We’re going to toss the inverse stock ETF right off the bat though, as while the potential is huge with these inverse ETFs in the right hands, the bouncy nature of this market puts skill at too much of a premium.
We aren’t out to ride out 1000+ moves against us and nothing even remotely close, as when this has happened, you had to be out and betting the other way. Investors might only get to watch their positions once a day and playing leveraged index ETFs on either side require more close monitoring than this and considerably more skill.
What we really want to be in are things that can be expected to move our way in a much more reliable fashion than this, instead of wavering between for us big and against us big. The other three qualify, the even more toxic oil and gas sector, bonds, and gold stocks.
Even though gold stocks are stocks, and virtually every stock is getting beaten up, the way that the price of gold is rising, this is propelling these stocks to double digit gains already this year. We’re also going to toss both gold stock and gold ETFs though, because while they do move a lot, they do so in not such a reliable way, as we saw in the last few days of February.
This leaves us with oil and gas stock ETFs and bond ETFs. If you consider that the degree of certainty that we’ve had about bonds going up and these stocks going down, this is what this is all about and how we can stand a little leverage. When we leverage, we are leveraging an advantage, and these two have provided some unbelievable ones.
The ProShares UltraShort Oil and Gas ETF has held the keys to some very nice profits lately. This sector was already mired in quicksand before the price of oil collapsed, and things have gotten really bad lately. We’re not talking about futures trading profits here, but being up 62% since February 20 is like investors getting handed several years of the best returns that they would normally even hope for in just 3 weeks.
The time to get in on this was earlier in the move than we are now, and the same is true for our bond ETF, but this does not mean that it is time to just be a spectator. As long as the world continues to tremble over this virus, luck is on our side, and as long as the cases continue to grow, it will remain so.
We get the added bonus here of oil stocks being so terrible otherwise that there’s a lot less risk for a bigger reversal, and this was going down plenty before this. However, this is not an ETF that you want to normally be in as an investor, because it is too volatile and nowhere near as juicy as its 95% year to date return would suggest. This does move, but in a way suitable for traders, not investors who just don’t normally want to keep things for just a few weeks. This is the exception and a strong one.
No discussion about financial assets would be complete these days without talking about bonds. The ProShares Ultra 20+ Treasury ETF isn’t up anything like the 62% our oil ETF is, but bonds are tamer than stocks even if they accelerate in a way that has never been seen before.
Still though, 29% since February 20 is pretty good for any asset, especially since this is the amount that the S&P 500 earned in a great year last year. When you do this in just three weeks, this is a move that is many times more potent than unleveraged positions on the long side see.
This is another coronavirus play, and if we can have such a persuasive force on our side, rather than against us, that’s amazingly valuable. The real beauty of this is that investors aren’t required to know anything about timing trades beyond just timing their exits in concert with the number of cases declining enough to wake people up from their nightmares.
We don’t even need to look at charts here, and when you can trade and not need any chart reading or other trading skills, this is a unique event indeed. Don’t fear it, cherish it.
Chief Editor, MarketReview.com
Ken has a way of making even the most complex of ideas in finance simple enough to understand by all and looks to take every topic to a higher level.
Contact Ken: ken@marketreview.com
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