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Short the Powershare QQQ (QQQQ) and DIAMONDS Trust (DIA) to profit from bear (market) territory

Posted August 21, 2008

“For seasoned traders, a major downturn is simply another opportunity to make money. The harder Wall Street falls, the more they will make. Smart investors use short positions in options and equities to bet against share price appreciation. It’s exactly what you should be doing.” — Andrew Snyder

by Andrew Snyder

Baltimore and Ketchikan, Alaska (TFN) – I saw the words scrolling across the bottom of the screen this morning as I munched on my morning bowl of cereal. With each bite of the crunchy meal, the message spelled itself out.

“Dow reaches bear territory once again,” the bold, red letters spelled.

As the talking heads on the screen continued to dissect the upcoming presidential election, I could not help but veer off into the world of economics, especially the rather unique economic state this country is in. That one simple sentence got my mind running in high gear and the sun was not even over the mountains yet.

For weeks now, the Dow has hovered just above official “bear territory,” the level that, depending on your definition, denotes a 20% drop from recent highs. We’ve reached the critical barrier several times, but have witnessed a small, but fortunate, bounce each time. It will not last.

In fact, it can’t. It’s impossible.

Times up, market’s down

Take a look at what’s going on: As each day passes, the so-called “short economic downturn” the nation’s economic leaders have promised not only continues, it worsens.

Oil prices remain high. The real estate market is crumbling. Unemployment rates are shooting up. And inflation is instantly eradicating any hopes of a quick way out. Wasn’t the second-half of the year supposed to mark a major rebound? Phooeey…

We are in the choking grasp of a strong cyclical downturn. The only way out is to scrape bottom, wait until the economic wheel stops turning, and hope it begins moving in the opposite direction.

You will know when we hit bottom the next time the message I mentioned above scrolls across your screen. So far, technical trading aspects are the only thing keeping this market afloat. As soon as historic levels are hit, automated trades are triggered and the market gets a strong, but temporary jolt of buying activity.

These computerized trades are the way institutional traders spread out their entry prices and protect themselves. The sudden activity is just enough to trick novice investors into believing the downturn is over.

Unfortunately, the money is quickly drying up. Soon, there will not be enough funds to create the bounces we have seen. We will officially enter bear territory and stay there for months, if not years. It will be a crazy, rough ride. But it could be a highly profitable one.

When most people are sure the market is going to head south, they sell their equities and head for cash investments. It’s great for protecting your hard-earned cash, but a horrific idea if you want to grow your wealth.

Technical bounce, fundamental losses

For seasoned traders, a major downturn is simply another opportunity to make money. The harder Wall Street falls, the more they will make. Smart investors use short positions in options and equities to bet against share price appreciation. It’s exactly what you should be doing.

Next time we see the markets flirting with bear territory, take a short position in one of the major ETFs that follow the overall market like the PowerShares QQQ (QQQQ:NASDAQ), which tracks the smaller, high-tech companies in the Nasdaq market, or the DIAMONDS Trust (DIA:AMEX), which tracks the nation’s blue chips.

If you really want to earn some money, enter a short-term put options play in the same funds. It is a bit riskier, but the rewards are exponentially higher. (Note: If I see a surefire options opportunity, I’ll let you know.)

It’s Econ101 all over again

No matter who the Fed bails out next or which major bank announces a huge write-off, the markets will continue their predictable actions. After all, the names of the companies and industries may change, but it is still the same economic laws and forces at work.

Once the wheels start to turn, you can’t stop them. You might as well ride the momentum and make some nice profits along the way. Don’t be scared of a bear market. It merely means you must adjust your strategy, invest wisely, and hang on for a wild ride. Smart investors are in for some exciting times.

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Posted by Andrew Snyder · Filed Under US Stocks and Markets 

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