SMSF Investment StrategiesSharing Simple Strategies for Self Managed Super Funds
How your SMSF can profit when the market goes down
Stock investors can only profit when stocks go up in price. The only way for a stock investor to profit in a falling market would be sell short but most people are uncomfortable with short selling. Short sellers are perceived negatively and are frequently blamed by regulators and company CEOs for causing stock prices to fall. Last year, short selling was even banned for a period of time in a bid to prevent the market from falling but as we now know, that did not work as markets fell even faster after the ban was put in place. In my opinion, short sellers actually help to stop prices from falling as they are the ones who need to buy stock to cover their short positions.
Short selling also has unlimited risk so it is not be allowed for a SMSF. If you buy a stock for $20 per share, the worst thing that can happen is if the stock price goes to zero and you lose the $20 you paid for the share. However, there is no limit to how much a stock price can go up to. If you (short) sell at $20 and the price goes up above $40, you will lose more than the $20 that you received for the share and your loss is theoretically unlimited.
Is there a way for SMSFs to profit in a falling market? Or are we expected to sit on the sidelines in cash as our best option? Fortunately, there are at least 2 ways we can profit in a falling market:
1) Buy put options
I have mentioned in previous posts about buying put options as a hedge or insurance for long stock positions. You can also just buy a put option on a stock or index, if you believe that the market is going down. For example, if a stock is trading at $20 and you think it is going down, you can buy a put option at the $20 strike price and if the stock goes down to $10, your put option will be worth at least $10 and if you sell that put option,you will make a profit of $10 less the premium you paid to buy that put option. The only problem with put options are that they have an expiry date. To make money with put options, you must be right with your market direction and timing. As with our previous example, if the stock price falls to $10 as you predicted in October but you only bought a put option that expired in September, your put option will expire worthless. My timing is usually not very good so I generally do not like to buy put options.
2) Buy shares in a inverse Exchange Traded Fund (ETF)
To cater for retirement fund investors in the US, who like SMSF investors are not allowed to do short selling, a company called Proshares have come up with some interesting ETFs which have an inverse correlation with an index to help investors profit from a falling market. These ETFs are known as inverse, short or bear ETFs. For example, they have a ETF called DOG whose price will go up when the Dow Jones index goes down. As you are buying shares and not options, there is no expiry date on these assets. When I was researching these ETFs, I found some interesting articles on the use of inverse ETFs written by Toni Turner, a very successful trader and active investor who has authored a number of best selling trading books. Check out this article How to Use Inverse ETFs for Profit and to Hedge and other related articles on the Trading Markets website written by Toni Turner. Toni is a personal hero of mine who inspired me to trade for a living as she is one of the few well known successful female traders and active investors.
These ETFs do have risks so it is important that you check out how the fund in structured by the ETF provider. These inverse and leveraged ETFs have come under some criticism recently as discussed in this video interview on Yahoo Finance.
Do your own due diligence before using them. I just bought shares in one of these inverse ETFs yesterday. I will share my research process and my trading strategy in a future blog post soon.
Print This Post
[...] fall. For more information about inverse and leveraged ETFs, please read my earlier blog post How your SMSF can profit when the market goes down. Of course, I could be completely wrong about market direction or FXP may not mirror the Shanghai [...]
[...] my Aug 19, 2009 post, I talked about a couple of ways that a SMSF can profit in a falling market which was [...]
[...] that could profit in a falling market like short or inverse Exchange Traded Funds (see earlier post How your SMSF can profit when the market goes down). Looking at our current investment strategy, our SMSF looks more like a hedge fund rather than [...]
[...] here, you may want to subscribe to my RSS feed. Thanks for visiting!In August 2009, I wrote about two strategies that SMSFs can use to profit in a falling market, which is to buy put options or to buy shares in inverse ETFs. The market has been falling for the [...]