Tuesday, August 12, 2008

Not going long in a bear market

Why don't I invest in SSO, SPY, or any other long ETF during a bear market rally? That's been the most common question in blog comments and e-mails recently, so it's worth putting one of my replies here in an official post:
We're in a bear market right now. During a bear market, the downward phases are bigger and take longer than the rallies, so a rally is a small target to hit compared to a retreat. The opposite is true during a bull market.

Sure, there's a tiny possibility (ha!) that I could make a mistake in the timing of an SDS purchase, but it would be no big deal, because I could just sit tight and wait for it to eventually go up in price when the bear market resumes.

But were I to make a mistake with the timing of an SSO purchase, (maybe the rally ends sooner than I expect) then there's no way to recover. I'd have to sell at a lower price and eat the loss.
Another way of wording this is that, in a bear market, the risk is higher and the potential rewards are lower for a regular (long) stock fund position than for an inverse (bear/short) fund like SDS. Higher risk with a lower reward is a double-whammy that I choose to avoid.

5 comments:

Anonymous said...

Thanks
Right on the mark again.
Straight forward analysis and answer to an on-going question regarding the "rally" within the bear.
the KD

Anonymous said...

Jody,

How did you determine your forecast of 940 for the S & P?

John said...

Hi Jody, Very wise! Defense wins the game. I think selling SDS and buying SSO pose similar risk. Timing an exit and re-entry is as difficult IMO. SDS lost about 17% so I imagine you don’t have to be too quick to get a little better price but a rally reversal could put an SDS exit in jeopardy just as quickly as an SSO entry. The trouble with avoiding any risk near bottoms is it’s nearly impossible to know which one of these bottoms will be it. The level of federal intervention in our “free” market has been historical.

1 more 50 point rally?

John

HKoldmanin TW said...

When is the ideal timing for loading SDS?
Thanx

Jody said...

John,

Selling SDS and buying SSO do not pose the same risk. The worst case scenario in my cash position is that the market moves while I gain nothing and lose nothing. However, an SSO position can easily lose more than 50% of its value very quickly in a crash. Besides, as you pointed out, SDS has already gone down in price, so there is a method to my madness.

If it were "impossible to know which one of these bottoms will be it," then I wouldn't be trying to time the market, and this blog wouldn't exist.

Finally, the amount of Federal intervention this time around is not that unusual. The government has always stepped in during crises to not only fix the current one but to take steps to prevent the next one. For example, the FDIC was created in 1933, and the Securities and Exchange Commission was created in 1934 as a response to the 1929 stock market crash - talk about intervention!