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Thursday, August 21, 2008

How to profit from the stock market collapsing?

UPDATE: Please see new blog post on double inverse funds broken
UPDATE2: See follow up comments
For most everyone I meet, if the topic of stock market arises, I can't seem to shut my trap. :)
Usually if asked, I'll recommend get out of the market and go into Federal Bonds or cash.
Problem with cash is, often, it's not true cash anymore but money market funds.
And money markets are NOT FDIC insured typically.

Often I hear people echo "but it's only 3% interest". Its much more if you count how much you lose by going long in stocks and the +3% you would have gotten if in bonds.

But for those of you out there, who want to take risk , you can buy funds that are called "reverse index funds" or "double reverse index funds".

An index fund is basically a bunch of stocks for a sector or market that are purchased and averaged to create a value. For example, say we pick 100 different stocks in the banking industry, and on average the value of the fund is "50 bucks a share", then the index fund we created for banking would be 50 bucks a share to buy. As the underlying stock values change, our index fund will change.

The good thing about index funds is you never take huge hits, but you also never have real winners. You get a piece of the action, but not extreme action.

A reverse index fund is the value of the target index fund, but it goes up when the target goes down. For example, if the bank index is 50 bucks, and the reverse bank index is 50 bucks, and the bank index goes to 25, the reverse goes to 75. For a double reverse index fund it would go to 100.

Unfortunately, it isn't this clear cut and simple, there are other factors that makes it not truely equal, but it's fairly close. Also, the change in a reverse or double reverse is NOT the same DOLLARS, but is the same %. For example, a bank index fund is 50, reverse is 20, when bank index goes to 25, the reverse goes to 30.

Double reverse has twice the reward and 3 times the pain. I say 3 times the pain since when the underlying fund goes up, the double reverse really accelerates down. Also it tends to "gap" down over night.

All are high risk relative to other investment vehicles. But for "relative" risk, lower is RWM, double short of transports. Does anyone thing transportation is a growth sector the next year? Next is QID, mainly since tech hasn't been crushed yet, QID has a bottom (not true bottom, historical) of 38-ish, now at 41. And high risk is SKF, short the financial stocks.

For information on the wide variety of double reverse or plain reverse funds out there, click on this link here.

*WARNING* These funds are not for long term holding, you buy and hold for a day, week, month, but not years.

Below is an example of QQQQ index fund vs the double reverse index fund, QID.
When the QQQQ goes down, the QID rises faster % wise. When QQQQ goes up, notice how quickly QID falls.

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