Nobody likes to feel trapped. You can be sure that a caged tiger would see you as his next meal, if it wasn’t for the bars between him and you.

A couple months ago, short ETFs liberated many investors. Today, we are feeling trapped by this range-bound market wondering where the next “meal” would come from. Ever since October’s waterfall decline, the major market indexes have bounced back and forward without any real net-gains or losses. The Dow Jones (AMEX: DIA) has been hovering between 8,000 and 9,000 while the S&P 500 (AMEX: SPY) has been confined to the 830 and 1,000 range.

Range-bound markets are like a pimple on the nose, you can’t ignore it but also don’t want to make it worse. For the present, range-bound markets are annoying but once the range is broken the market either becomes your friend or your enemy.

Making the best of a range-bound market

Neither day-traders nor buy-and hold investors like a range-bound market. Day-traders prefer heavy up and down swings like we’ve seen 6-8 weeks ago. Long-term investors are itching (and hoping) for the markets to move higher to erase at least some of those heavy “paper-losses”. Just like a turn-out on a long and winding road, a range-bound market gives you time to think and reassess your strategy.

To benefit from a range-bound market you need to make sure you won’t get surprised. I know this sounds impossible, the market tends to surprise investors on a daily basis. The biggest surprises to avoid are large break-outs in the wrong direction. What is the wrong direction? The wrong direction is a break-out that loses you money.

Be aware of the bigger picture

Be sure to know the general direction of the market before arranging your portfolio. Even an incorrect short term bet will eventually be corrected by the larger long-term move as long as your assessment of the general trend is accurate.

Here is a small scale example. Already in early October we recommended short ETFs (also called inverse ETFs) and alerted subscribers to our ETF Profit Strategy Newsletter that the Dow will have to break below 7,500 before bottoming. Even though there were larger one-or two day bounces on the way to Dow 7,445, any brief losses in short ETFs were reversed and rewarded eventually.

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ETF profit strategies

We won’t know for years whether Warren Buffett’s “cash is trash, I am all in” philosophy was the right thing to do. So far it doesn’t look like it. Regardless, a well diversified asset allocation strategy is a point to start but not the end-all answer. If you’ve had a properly allocated portfolio over the past years, odds are you are still 30-50% in the red. Why?

Declines were seen across the board. International stock indexes such as the iShares MSCI EAFE (NYSEarca: EFA) fell even harder and faster than domestic stocks. Commodities ranging from gold (NYSEarca: GLD) and silver (NYSEarca: SLV) to oil (NYSEarca: USO) and grains (NYSEarca: DBA) didn’t provide any protection either.

Even though asset allocation is the “white color” way of investing, it doesn’t make you much money in this market. It helps to allocate a portion of your portfolio to, what I call, selectively opportunistic investing. This includes the use of short, leveraged, sector or broad index ETFs. Short ETFs open many doors previously closed to the average investor.

We’ve recommended our first leveraged short ETF (ProShares UltraShort Financials, NYSEarca: SKF and ProShares UltraShort Real Estate, NYSEarca: SRS) over 18 months ago and were rewarded handsomely. Keep in mind, SKF and SRS can bounce or drop more than 30% a day and therefore should be enjoyed responsibly.

Last week, we introduced the “teeter-totter” strategy (see image below). This strategy can be applied to both short (or bear ETFs) and leveraged long ETFs (a short ETF is not the same as shorting ETFs). This strategy, if used correctly, also includes a conservative component. Furthermore, this strategy can be used to hedge current positions or simply to profit from the markets movement.



To continue with the example given earlier, in October, at Dow 9,500, we expected the Dow to drop below 7,500 before the next advance. This was the time to buy a leveraged or leveraged short ETF  such as the ProShares UltraShort S&P 500 (NYSEarca: SDS) or Rydex Inverse 2x S&P 500 (NYSEarca: RSW).

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The lower the market drops the higher the odds for a larger bounce. Therefore you liquidate the short ETF in stages as the market falls. One third of the short position is sold at Dow 8,700, the next third at Dow 8,000 and the final third at Dow 7,500 and below.

You could have applied this strategy with long ETFs starting at Dow 7,500 and will probably get a chance to switch back to short ETFs at around Dow 9,500. This approach works as long as the range is maintained or as long as you are on the right side of the market.

Once again, the key is knowing the prevailing trend of the market to avoid getting burned.

How to identify the prevailing trend

Market indicators have much in common with a puzzle. One indicator interpreted out of context represents as much of the bigger picture as one piece of the puzzle. That is why you hear so many differing analyst forecasts, most of which prove wrong. To identify the prevailing trend you have to determine the markets TRUE value in REAL money.

The Dow Jones measured in inflated dollars does not accurately represent its TRUE value. The only REAL value gage is gold. The Dow measured in gold clearly shows where the markets are headed. Another true cornerstone are dividends.

The only REAL money companies distribute to shareholders are dividends. In essence the company pays the shareholder in cash, an honest indicator. A comparison of historic dividend yields with today’s dividend yields provides another hint of the market’s prevailing direction. The December issue of the ETF Profit Strategy Newsletter discussed the implications and surprising results of REAL money valuations (the Dow measured in gold and dividend yields).

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