Sunday, July 20, 2008

My Plan to Profit from a Bear Market Bounce

Once again the government has stepped in and prevented a major financial crisis, this time with Fannie Mae and Freddie Mac. Investor confidence rose and the market rallied. I expect the rally to continue, at least for this week and perhaps for several. However, I believe that this will only be a bear market rally, because the housing correction, financial crises and high energy prices will continue.

Here's how I will look to profit from this rally:

  1. Continue to increase our cash position. In the last rally, I increased our cash position by selling the positions in our trading account and a small portion of our managed account, all at a profit. Unfortunately, based on the decline in June, 2008, I didn't sell enough :-(

  2. Buy small trading positions in stocks I expect to rally. I will take small positions (10 to 50 shares) from my 7/7/08 buy list. This past week, I added 10 shares of Potash (POT) and 50 shares of Southwestern Energy (SWN) to my trading account, which already had 50 shares of Range Resources (RRC).

    I will sell out of these positions when it appears the rally is ending.

  3. Look for additional stocks to short. The bear market rally should create additional opportunities for shorting stocks. My 7/7/08 list of stocks to short included Las Vegas Sands (LVS), Sears Holdings (SHLD), and Life Time Fitness (LTM). I had eliminated some stocks due to the price being below $10. The rally may lift some of these stocks above $10.

    For perspective, I do not plan to short any energy stocks at this time. Too risky.

  4. Buy an ETF that shorts financials. It's hard for me to believe that the crisis in our financial systems is over. I expect at least one other major financial upset, perhaps another investment bank failure (e.g. Lehman) or multiple regional bank failures.

    In the past, I've been reluctant to short an individual financial stock for two reasons: 1) the high probability of a sharp bounce like the one last week; and 2) the high dividend (e.g 5% or more) paid by most financial stocks. However, the UltraShort Financial ProShares (SKF) ETF offers a lower risk way to short financial stocks. If this ETF gets close to $100, I will purchase some shares. For reference, it closed at $138.00 last week, down from a high earlier in the week of $211.75.
Finally, to keep from being suckered into this rally, I will keep repeating, "This is just a bear market rally." :-)

Disclosure: At the time of publication, I own Range Resources, Potash and Southwestern Energy in my trading account. Our managed accounts own Range Resources and Sears Holdings.

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This is not financial or stock investment advice. Please consult a professional advisor.

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