Which of These Investors Are You?

Yesterday’s technical look at ProShares Ultra Financials (UYG) didn’t help much, as it showed a slightly bullish bias going into a day that saw the market sell off again to the tune of -9% for the S&P; 500.

It’s important to distinguish your time frames when trying to profit from this market. If you’re looking to pull money from it each day or week, then tight stops are essential, per my Tuesday article on UYG and ratcheting stops higher to lock in gains. The leveraged ETFs are moving so much each day that they’re like money machines if you watch them closely and catch just a small part of a trend — or a big trend like Monday’s surge higher for the longs or yesterday’s plunge lower for the shorts.

Here’s how that can look when done right. On Monday, you would have seen UYG bouncing off support at $10 after surging upward from $8 Friday. You wouldn’t care about missing the 25% run from $8 to $10 (unless you already owned it on Friday when it was bouncing along $8, but let’s be conservative and say you didn’t). You just pick up whatever number of shares you want at $10.05, put a stop on them at -5% or $9.55, then move the stop up as the shares rise. By the end of Monday, UYG was at $11.25 and you would either have sold to avoid overnight surprises or set your alarm to start Tuesday with the market to keep on top of it.

The Tuesday pre-market made it obvious that UYG was set to move higher again, and indeed it did. That was stop ratcheting time, which worked to get traders out of UYG at around $12 for a 20% gain.

Long-term investors, on the other hand, should approach bargain prices differently. The jury is still out on how severe a recession we face, whether government moves will stave off a systemic financial meltdown, and so on. Everybody is saying they’re going to wait and see. The truth is, though, that the jury is always out. There’s never a clear signal in the market. It’s always uncertain.

Which is why moving gradually makes sense. One thing we can all agree on is that the risk in the stock market is less today than it was a month ago. You read that right. Prices are lower. Money put into shares now will appreciate more than money put in a month ago. If stocks fall farther, money put in now will not have fallen as far at the bottom as money that was put in a month ago. That’s lower risk.

But we all know that it sure doesn’t feel lower. It feels like risk is at an all-time high, that the last place you’d want your money is in the nutty stock market where all recent comparisons go back to the Great Depression. One thing to remember about the Great Depression, however, is that it was a pretty good time to buy stocks — but not all at once because there were several bear market bounces and then more legs down before it based and rose.

So, the long-term investor recognizing that these days are pretty good for putting money to work in stocks, should divide his or her capital into chunks and dollar-cost average into broad indexes, either leveraged or plain. The volatility will continue, and that’s why moving gradually will remove some of the stress.

Look at ProShares Ultra S&P; 500 (SSO), for example. If you’d begun moving capital into it when I wrote on Oct. 8 that you should “get your greedy hat out,” you would have paid around $30 for it the next day. On Monday, it closed at $35.50 to give you a quick 18% gain. Now, it’s back down to $29. So what? You don’t need that money now. Let it ride.

If the worst prediction I’ve read comes to pass, we’ll see the S&P; 500 fall another 30% from yesterday’s close. That would take SSO down 60% from $29 to less than $12. It would likely happen in the next six months or so, which means that the smart long-term dollar-cost averager would divide capital into six chunks, one for each month. The first chunk went in at $30, maybe the second one goes in at $25, the third at $20, the fourth at $15, the fifth at $10, and the sixth at $15 as the market finally starts its way back up. Here’s how that would look if each chunk were $10k:

  • 333 shares at $30
  • 400 shares at $25
  • 500 shares at $20
  • 667 shares at $15
  • 1,000 shares at $10
  • 667 shares at $15

The $60k invested would buy a total of 3,567 shares at a cost basis of $16.82.

The S&P; 500 would be at around 700 at the end of this six-month scenario. Its slow climb back to the 1,400 level — where it was just last May — would see the investor’s $60k become $180k.

Those are the two ways to approach this market, and neither is particularly stressful. Choose which kind of investor you are, and put the plan in action.

If neither appeals to you, then do absolutely nothing and feel no regret for it. There’s no law saying you have to invest in stocks just because so much is going on in the market. Cash is cash, it’s great to have, and I’ll bet you could put some of it to fine use on holiday shopping lists.

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