Introduction


The Exit Cafe is dedicated to helping investors and professionals of all experience levels be more aware of changes to their risk exposure and the importance of using an intelligent exit strategy to control and act upon risk.

The editorial manager and a frequent contributor to our blog is Chuck LeBeau, an industry leader in the application of technical analysis for risk management. We hope you find our blog enjoyable, educational and valuable. Please feel free to chime in on any stories or analysis posted.

Mar 30, 2009

Strategies of Portfolio Protection

SmartStops commentary: Below are some ideas for using ETFs to hedge a portfolio. The list of ETFs that go short is worth saving.



Investment Portfolio Protection

Strategies of Portfolio Protection

http://knol.google.com/k/samuel-gap/investment-portfolio-protection/7x625mtk3b8m/11#


These days the question of how to protect the investment portfolio becomes essential and central.

Most of us have lost some (or big) money as result of the Subprime crisis. Since this crisis crossed borders and sectors most of the individuals’ and corporations’ investment portfolios had to suffer. Even cases of sophisticated and wise investors could not show positive returns on the portfolios as the market trends and physiology around the world were negative. In such days the question of how to protect the investment portfolio becomes essential and central. Obviously the ultimate way to protect the portfolio is to sell it and hold cash only – however this is only a theoretical solution since investors expect some returns on their money and selling the entire portfolio can also cause huge transaction costs.


Portfolio Protection – Introduction

In the last decades the financial markets evolved to enable professional investors to protect their investments by short and hedge position. The simple way of protection is by purchasing PUT options or Future contracts betting the decrease of a specific company, sector or market. These instruments are costly as they reflect the option and time price in the option price. These instruments also require the investor not only to bet on the direction of the share or market (increase or decrease) but also to bet the timeframe since options and contracts expire at a certain date. Another instrument which requires high expertise is short selling of specific shares covered by stock lending arrangement. The latter enables the investor to sell shares that he does not own and buy later buyback the shares at a lower price (in case the bet succeeds and the share price falls). This short selling requires complicated procedures and high sophistication and usually cannot be performed by an ordinary individual. Therefore, the next step of the market evolvement was of professional fund managers to offer the public many types of mutual funds, hedge funds or private fund that manage short positions on specific markets or sectors. Recently, some fund managers also offer equity traded funds which aim at inverse exposure to specific sectors or indexes. These ETFs are simple and quick way to protect a portfolio and the transaction (buy/sell) is handled like any other listed share in the market.


Thus, an interesting protection structure which investor may choose is to hold shares and funds of markets and sectors he believes will perform well (“to go long”) and to purchase short ETFs or funds in markets or sectors what he believes will underperform (“to go short”).


Such a structure will enable you to be more balanced on your entire portfolio if markets will continue falling crossing all sectors and markets (in such case your short funds will make some gains), but will still allow you to bet on specific markets and sectors you believe will rise or fall. When buying short ETFs important to notice that some of them are leveraged and volatile promising the investor “twice the inverse daily return of the index”.


ETFs Short Funds:

Below are some examples of “bear market” (short position) ETFs traded in the US markets-


UltraShort SmallCap600 ProShares (US symbol: SDD) which goal is to “correspond to twice the inverse of the daily performance of the S&P SmallCap 600 index”. http://finance.yahoo.com/q?s=sdd


Short Russell2000 (US symbol: RWM) which goal is to “correspond to the inverse of the daily performance of the Russell 2000 index”. http://finance.yahoo.com/q?s=rwm


UltraShort Industrials ProShares (US symbol: SIJ) which goal is to “correspond to twice the inverse of the daily performance of the Dow Jones U.S. Industrials index”. http://finance.yahoo.com/q?s=sij


UltraShort Consumer Services ProShares (US symbol: SCC) which goal is to “correspond to twice the inverse of the daily performance of the Dow Jones U.S. Consumer Services index”. http://finance.yahoo.com/q?s=scc


UltraShort MSCI Emerging Mrkts ProShares (US symbol: EEV) which goal is to “correspond to twice the inverse of the daily performance of the MSCI Emerging Markets index”. http://finance.yahoo.com/q?s=eev


UltraShort FTSE/Xinhua China 25 Proshare (US Symbol: FXP) which goal is to “correspond to twice the inverse of the daily performance of the FTSE/Xinhua China 25 index”. http://finance.yahoo.com/q?s=fxp


UltraShort Financials ProShares (US Symbol: SKF) which goal is to “correspond to twice the inverse of the daily performance of the Dow Jones U.S. Financials index”. http://finance.yahoo.com/q?s=skf


UltraShort Oil & Gas ProShares (US Symbol: DUG) which goal is to “correspond to twice the inverse of the daily performance of the Dow Jones U.S. Oil & Gas index”. http://finance.yahoo.com/q?s=dug


UltraShort Technology ProShares (US Symbol: REW) which goal is to “correspond to twice the inverse of the daily performance of the Dow Jones U.S. Technology index”. http://finance.yahoo.com/q?s=rew


UltraShort MSCI Japan Proshares (US Symbol: EWV) which goal is to “correspond to twice the inverse of the daily performance of the MSCI Japan index”. http://finance.yahoo.com/q?s=ewv


UltraShort Utilities ProShares (US Symbol: SDP) which goal is to “correspond to twice the inverse of the daily performance of the Dow Jones U.S. Utilities index”. http://finance.yahoo.com/q?s=sdp


UltraShort Semiconductor ProShares (US Symbol: SSG) which goal is to “correspond to twice the inverse of the daily performance of the Dow Jones U.S. Semiconductor index”. http://finance.yahoo.com/q?s=ssg


Disclaimer:

The information contained in this article and from any communication related to this article is for information purposes only. The author does not hold itself out as providing any legal, financial or other advice, and is not authorized to do so. The author also does not make any recommendation or endorsement as to any investment, advisor or other service or product or to any material submitted by third parties or linked to this article. In addition, the article does not offer any advice regarding the nature, potential value or suitability of any particular investment, security or investment strategy. The material in this article does not constitute advice and you should not rely on any material in this article to make (or refrain from making) any decision or take (or refrain from making) any action.

Mar 11, 2009

Stupid Investment of the Week

Stupid Investment of the Week

Commentary: Find a stop-loss point before you go any further with stocks

By Chuck Jaffe, MarketWatch


BOSTON (MarketWatch) -- Maybe you're investing because you believe that stocks are "on sale," or perhaps it's because you believe in the long-term prospects for recovery. Perhaps you hold stocks that have been good to you in the past, or which you've been in so long that you don't want to go through the headache of calculating your capital gains.

Or you could be trading for a quick profit, or following the discipline of dollar-cost averaging.

Whatever the reason, if you haven't come up with a stop-loss point -- either a real trigger to get out of an investment if it falls too far or an emotional point where you would sell -- you're making the Stupid Investment of the Week.
Stupid Investment of the Week typically highlights conditions and characteristics that make a security less than ideal for average consumers, focusing on one example to showcase common pitfalls.
This week, however, the trait under review belongs to the investor and not the investment. Specifically it's about people who buy or hold a stock in a trader's market without having a concrete exit strategy.
"The hardest thing investors have to do is to determine when they can make money in this kind of market, and when they have to preserve capital, because those things are often at odds with each other," said Richard Geist, head of the Institute on the Psychology of Investing.
He added: "You are looking at something saying 'It's a bargain,' or feeling like it can't go down much further from here, and yet you are also looking at your portfolio and wondering how much of a loss you can take if you are wrong."

Set limits

There are plenty of stop-loss strategies, typically involving a standing order to sell shares if they fall to a specific level. That said, rigid stop-loss programs typically are wrong for casual investors, as they can trigger losses again and again, especially in a volatile market.
So while many investors who follow trading systems will always set a stop-loss at, say, 8% or 10% down from their buying point, an average investor could find themselves with a slew of investments all delivering a quick loss and never reaching the longer-term prospects that are behind the holding.
"A trader or someone with a system basically is using stop-losses to avoid being wrong," said Ken Shreve, markets desk anchor for Investor's Business Daily. "Someone who buys and holds blue-chips, they're trying not to be concerned with the short-term losses, figuring that they will get paid off over time."
But, he added, "At some point, however, those losses start to add up and the math is not on your side. The problem with riding things down is that a 50% loss in a stock requires a 100% move back up. ... The math is the best argument for basically setting a selling point, one where you avoid losses or protect your gains."
For long-term investors, finding a selling point may not mean setting a stop-loss order at a specific price per share. Instead, it may be an emotional price, one where the investor says they are willing to gamble with some of their winnings, but they are not going to allow a long-time winner to morph into a long-time loser.
Unlike the person with a trading strategy, who takes proceeds from a stop-loss trade and puts it toward the next investment that meets their buying profile, a long-term buy-and-holder is looking more to create their reason to get out the door, without regard to the next investment. They are more concerned about protecting what they have than finding a faster horse at the track.
Consider General Motors (GM) , which was trading 12 months ago north of $26 per share. At that price, there were still plenty of long-term believers, employees and former workers with huge slugs of stock in their retirement plan and more. While the market was waking up to the problems that have led to the company calling for a federal bailout to avoid bankruptcy, the long-term, 'I-have-faith-in-America, it's-too-important-to-fail' crowd was hanging on, and their accounts were being slaughtered for it.

Avoid the worst

Likewise, the financial services industry spent the late 1990s and early 2000s rewarding investors many times over, and yet a long-term holder who simply figured "things couldn't get much worse" basically has watched decades of gains evaporate.
Behavioral finance experts say that investors tend to go through a progression that includes some measure of denial about just how bad things can get. When they wake up to horrendous losses, they are looking at account balances so low that they may ride things out until the bitter end.
Instead, Geist noted, they should have a mental selling point, one where they say they will allow that long-term winner to shrink back to maybe double the initial investment or all the way to break-even, but that when it reaches those scary levels it gets sold in order to avoid the possible bitter end.
This "emotional stop-loss" is just as important as the actual trade; effectively, it is like setting your limit at the casino and saying "this is the point beyond which I need to stop gambling."
And while some of the issue is based on emotions -- the point where you start losing sleep at night based on the shrinking value of your biggest holdings or your entire portfolio -- some of the decision will also be based on your needs and plans.
"The more stress people are under, the worse their decisions tend to become," Geist said. "So if you are holding something today and you know there is a point where enough is enough -- where you just can't take more loss or you just have to acknowledge that whatever had you buying or holding the stock just isn't working right now -- that point becomes your emotional stop-loss. If you know it in advance -- and setting it is the hard part -- it will protect you from letting things get worse while you try to figure out if you should hang on or not."

Chuck Jaffe is a senior MarketWatch columnist. His work appears in dozens of U.S. newspapers. www.marketwatch.com
Article: http://preview.tinyurl.com/aqvtd5