Trading Strategy Using Index ETFs

Strategy:  This trading strategy involves using short, double short, and triple short major index ETF's when the major indexes of the stock market make a major move.  A major downward move could be defined as seeing the Dow Jones 30 index go down by at least 1000 points.

Timeframe:  That timeframe for this kind of a trade is a medium time range, that is, you are looking at a hold of the ETF stock for several weeks and up to several months till the stock market completes its major move.

Overview:  There are a variety of ETF's that have been established to short, double short, and triple short the major stock market indexes.  This includes the Dow Jones 30, the S&P 500, the NASDAQ and the Russell indexes.  So, for example, and ETF that is designed to double short the S&P 500 index will go down in value as the S&P 500 index goes up.  But, when that index starts to go down this ETF will go up in value.  In fact, the idea of double shorting is that as the index moves down the value of the ETF will go up faster than just a straight shorting of the index.  It may not go up in value twice as fast but it is expected to go up in value faster than just a single shorting of the index.

The idea of this trading strategy is that as the major indexes of the various stock markets top out after a major move upwards you can get in to one or more these ETF's with reduced risk as the most likely next move for the stock market is some kind of a move downward.  This means your entry point into the ETF doesn't have to be so precise because as the indexes begin to top out the ETF price, stabilize and however within a certain range which will allow you to get a good entry price without having to use purchasing strategies to attempt to get the best price possible in order to maximize your profits.  For example, an ETF that is trading between $22.50 and $23.30 because it's index is hovering at its peak is not going to make too much of a difference whether you got it at the $22.50 price or somewhere in between up to $23.30 when a major move on the underlying index will cause the price of the stock to double in price.

Keys: Of course the major key is being able to know when the stock market is going to make a major move downward.  Perhaps the best key is when one or more of the major indexes have pushed through to new highs.  They will usually pushed through, breaking old records, and continue to do this for several weeks.  They may however and then move up some more.  They may even Spike upwards.  But at this point you know it's going to come down.  The stock market does not go up forever.  So I believe the key is to let the stock market peak go over its peak and begin to look like it's starting to trend downward before getting into one of these ETF's.  Political and economic news both nationally and globally will also play a part in helping you determine when the stock market is going to start moving downwards.

Strategy Pros:

·         The moves of the major indexes whether it's the S&P 500, NASDAQ, or Dow Jones 30 are relatively slow compared to the moves of stocks.  This allows you to watch the index, take your time and pick your entry point when it appears the index is going to make a move downwards.

·         There may be more of a predictability with the price trend of this kind of ETF because the ETF is being shorted against a stock market index then if you were trying to predict the move of a stock of a company.  For example, if you buy a $25 stock in a company you are going to have to do some analysis whether technical or fundamental or both on that company in order to understand if over the next several weeks or months that $25 stock has a chance to move to $30 or $40 or $50.  But the major moves of the indexes might be much easier to see.  While there are both technical and fundamental analysis that you can make on the major indexes as well as a stock market that might tell you whether it's going to make a move down or move up is also much easier to see that when the Dow Jones 30 pushes through to a new high for several weeks or several months, regardless of the economic conditions it's probably not going to keep going up too much longer and that you're going to have a downturn or correction, something which you can take advantage of through one of these ETF's.

 

Strategy Cons:

·         Because these ETF's are shorting stock indexes the price of the ETF's can be higher then may be comfortable to some investors.  You are looking at prices of anywhere from over $20 per share to over $100 per share.  That means that you may not be able to get as many shares as you want and make as much as you would like on a particular index move.

·         This is a strategy that you may only be able to use two or three times over the period of several years.  You're going to tend to want to wait until the stock market has moved to a new high or to some new level before you get into this strategy, you are holding it for several weeks and perhaps several months before you get out.  Then you will have to wait until the stock market stabilizes and moves back up to another new level before you could exercise the strategy again.