Using the Bear Market Paddle Strategy

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Jan 23rd, 2008 | By | Category: Investing Strategies

We all saw it. We all know what happened…

World markets collapsed everywhere over the weekend.

Tokyo’s major index, the Nikkei 225, fell 9%; the FTSE 100, London’s rule of thumb, fell 9.5%; and the Hang Seng Index, Hong Kong’s benchmark, sank 10%. The list goes on and on…

And when we look at what happened to the U.S. markets at the start of business yesterday, we saw some of the largest drops since the market opened September 17, 2001, following the 9/11 attacks. Not even the Fed could stop it with its 75-basis point cut in interest rates.

But what we pay particularly close attention to when we see the market moving so quickly is the Russell 2000. It is our benchmark. It represents the small-cap sector of the U.S. market. And unfortunately for us, we’ve seen that fall even further than the rest. It’s down close to 16% over the past month.

This always happens in bad markets. Smaller companies take larger hits. They live and die on liquidity, and without that, they dry up and fade away. Now, of course there are always exceptions to the rule, which we do our best to uncover here at Penny Sleuth. But finding that needle in the haystack isn’t exactly a cinch.

We’ve laid out strategies, screens and even specific companies to invest in that act as safety nets in bear markets, but that’s just protection…

What would you say if I told you that there was an insurance policy for small-caps that also lets you double your money as everyone else loses theirs?

I’m guessing you’d take it.

Well, with a special technique you can protect your investments by betting against stocks that you think are going to go down even further. Let me show you…

Here is a chart that shows how the Russell 2000 Growth ETF — which is just a way to invest in the performance of the Index — has done over the past month:

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With this special strategy, your chart would’ve looked like this:

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You can see that with this $4.25 insurance policy, you could have nearly doubled your money, while the Russell 2000 fell about 16%.

Now, I’m not saying that you should bet against small-caps. They are our lifeblood over here at Penny Sleuth headquarters. You should stay vigilant with your long positions. Don’t bail on them out of fear. Remember why you invested in the first place.

However, when the small-cap stocks take it on the chin, this highly profitable insurance policy that can erase whatever short-term losses the market delivers to your long positions.

A few of us around the office call this type of strategy an “insurance policy” because it allows protection and profit as markets crash. Others around the office refer to it as a “paddle strategy” because you will have to use it to paddle your way through the flood of falling stocks.

No matter what you call it, it’s still a little known strategy that you should look to take advantage of right away.

Sincerely,

Jim Nelson
January 23, 2008


Author Image for Jim Nelson

Jim Nelson

Jim Nelson began his investing career during the tech boom at age 14 – with purchases of Starbucks and AOL. Early inspiration came from an old Tweedy Brown whitepaper: “What Works in the Market.” He graduated with a degree in Political Science from Pittsburgh University, Nelson focuses on income investing, including dividends, covered calls, and fixed-income. Additionally, he covers MLPs, ADRs, utilities, consumer staples and tobacco. Nelson is the managing editor of Lifetime Income Report.

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