The Voodoo That You Do

One of the reasons I chose to invest in the Direxion Small Cap Bear 3X Shares (TZA) is that it primarily contains small cap stocks and small cap stocks traditionally have a high BETA. What this means is that if the market starts to tank, you will get more of a gain if you are on the short side. So if the market does go down, not only will I be leveraged 300%, but I will also make much more than if I would have shorted the S&P 500. However, it also means you will lose more if you are short and the market begins to rally. For those of you unfamiliar with the BETA or BETA Coefficient I'll give you the definition supplied by my trusty Barron's Dictionary of Business Terms. "BETA Coefficient: Measure of a stock's relative volatility. The beta is a covariance of a stock in relation to the rest of the market. The Standard and Poor's 500 Stock Index has a beta coefficient of 1. Any stock with a higher beta is more volatile than the market, and any with a lower beta can be expected to rise and fall more slowly than the market". I couldn't have said it any better myself.


At the present, I am up 24% for the month that I have owned the Direxion Small Cap Bear 3X Shares (TZA). Up 24%. Maybe it's time to take some profits? I don't think so. I tend to let my holdings run for more than 12 months to take advantage of the tax laws. If you sell before the 365 day holding period, you are subject to capital gains at ordinary income rates which run around 35%. If you hold your positions for over a year, you can take advantage of the long term capital gains rate which varies on your income level from anywhere from 5% to 15%. There are circumstances when you have to sell before 12 months, like when you are in a big mover that triples or quadruples in just a short period of time and you think it's going to come back to earth, but for the most part, it's better to hang onto your shares for 365 days.

The portfolio I'm working with here is in a taxable account and I have to make investing decisions that take the IRS into consideration. I feel strongly enough about the economy taking a double dip in 2010 that I am willing to let my leveraged holdings run until after the 365 day holding period. However, you know what they say about best laid plans. I'll just let the shares follow the economic cycle until I feel it's time to get out and go long or go into cash for awhile. Most of the information I've come across about leveraged ETFs states you should hold the shares for short periods of time, even just days on the 300% leveraged products. I disagree in this circumstance because I believe the market will be considerably lower a year from now. I may get my head handed to me, but I'm willing to take that chance.


When putting my remaining cash to work last month, I considered buying 2,000 shares of the Direxion Small Cap Bear 3X Shares (TZA) ETF, but decided to go with 1,000 shares instead for the simple reason that I chickened out. Half of the portfolio leveraged 300% was too much risk for my blood. I really don't know where this market is going. Nobody does. Not George Soros, not Warren Buffet, not Carl Icahn and certainly not me. I can only make an educated guess and I've been wrong so far, but I'll stick to my guns. I had a good week, up $5,400. It's a step in the right direction, but I've got a long way to go before I'm back to even.

Leveraged ETFs

Exchange Traded Funds or ETFs are basically mutual funds that trade just like stocks which makes them much more liquid than your run of the mill mutual fund. ETFs primarily come in three flavors: country based, sector based or index based although this past year there has been an influx of commodity and specialty ETFs introduced to the investing community, but these new funds are in the minority. In addition, actively managed ETFs are starting to make their way into ther market. Besides the liquidity factor, a low expense ratio has made ETFs a very popular way to invest your money the past five years. Personally, I prefer to be a stock picker, but sometimes circumstances dictate a change in strategy which is why I've utilized ETFs for the past six months.

I'm currently in leveraged ETFs to the short side and as a retail investor, this can be a boon or bust to your portfolio. Until last year this would have been almost unheard of for a small retail investor because leveraged index funds to both the long and short side had high minimums for investing. For example, ProFunds (the parent company of ProShares) required a $15,000 minimum for each of their leveraged funds and Rydex required a whopping minimum of $25,000 for each leveraged mutual fund. Now all you have to do is pay a commission for the trade (which is nominal at a discount broker) and whatever the cost of the shares you purchase at the market's going rate. The major players in leveraged ETFs are ProShares, Rydex and Direxion. To find out what products they offer, just go to their respective Web sites and download the prospectus that is applicable to your needs.

Now you may be wondering why I use leveraged ETFs as opposed to just playing the options game or shorting indivisual stocks. The answer is that it's safe and easy (if you consider being leveraged 300% safe). Only professional traders should use options and I don't care what the pundits on CNBC and Bloomberg tell you. Statistics show only 15% of retail options traders make a profit. Not only do you have to pay capital gains at ordinary income rates for your derivative trades, but you also have to be glued to your computer to try and beat the market. If you short individual stocks (yes, you can short ETFs, too), you have to have a margin account and can have the shares called in at any time by your broker.

With leveraged ETFs, and this is for both long and short positions, you let the issuing ETF company do the heavy lifting by not only shorting the shares, but also playing all of the derivatives games. No muss, no fuss, no wear and tear. Leveraged ETFs let you take very risky bets without the hassle. On a tax basis note, one of the ETFs I am currently invested in, the ProShares Ultra Short S&P 500 (SDS) pays a yearly dividend, so you will have to pay attention to the dividend date to reinvest your shares if this is an option for you. I do not recommend using the dividend reinvestment option with your broker because it a nightmare at tax time when you sell with all of the fractional shares. If you have an IRA, then that's a different story.

P.T. Barnum

P.T. Barnum is famous for saying "there is a sucker born every day" and that quip could probably be applied to me when you consider I'm down nearly 30% of my original investment in only three and a half months. But you must consider I'm playing with fire when I'm in ETFs that are leveraged 200% and 300% to the downside. The game I'm playing is financial Russian Roulette with heavy bets that I don't put the bullet in my temple. Believe it or not, I am primarily a value investor. I don't agree with the Efficient Market Theory where investors believe that stocks are always fully priced and you can never beat the market. I'm from the school that stocks go on sale and can also become overvalued and this holds true for the indexes like the Dow Jones Industrial Average and the S&P 500, too.

The historical average for the Price to Earnings Ratio on the S&P 500 is 12 according to Jeremy Siegel and the Standard and Poors Web site's 2009 projection is very high with an estimate of 20. The market has risen for seven straight months with no correction greater than 4% until yesterday when it hit 5%. This is unheard of after a 60% gain and I know that John Maynard Keynes said "the market can stay irrational longer than you can stay solvent", but I'm willing to take my chances. I'll stick with my short positions and take the ribbing and peer pressure that goes along with going against the grain.

I know there are a lot of hucksters in the market and I may very well be one of them, but I've been through two major crashes in twenty years and stayed long when all of the potentates said it was different this time, to hang in there because stocks would keep going up. I went against common sense and ran with the herd. Oh, it was sweet when my portfolio was climbing, but boy did it hurt when I clung to my holdings and watched my profits fall into the abyss. Not this time. No thank you. It is time to circle the wagons.

To the uninitiated, short selling can be considered Un-American. You are betting against your country and countrymen. I'm a firm believer in the American Way, the American Dream, God Bless America and most importantly, the American Business Cycle. Approximately every forty years we get a purging of the bad debt in the monetary system and we go into deep recession or depression. It happened in the 1890's, 1930's, 1970's and now the chickens have come home to roost. The stock market is a big casino and if you don't think so, just look what happened to your portfolios in 2000 and last year. It's not like putting your money in the bank. You are taking a calculated risk when you buy securities. Buying, selling and shorting stocks is a zero sum game. There is a winner and loser on every trade. It's is just the way the system works and by no means is selling a stock short Un-American.

PortfolioLive

Any good carpenter will tell you you need the right tool for the right job and so it goes with portfolio monitoring. It is no secret for those technically inclined that we are in a convergence of the cell phone and the desktop computer with the smartphone. It is also no secret that the national rage in smartphones is Apple's iPhone. I don't own an iPhone because the service plans are too expensive for my budget at the present time, but I do own an iPod Touch which Steven Jobs calls "an iPhone with training wheels". Basically, the iPod Touch is an iPhone without the cell phone capabilities - you can still do e-mail and run all of the applications if you are in a WiFi hub. Good enough for me because I'm usually within stone's throw of a WiFi hub.

I have tried many of the portfolio trackers available for the iPhone and iPod Touch including the one that comes standard with all Apple mobile products. Most of them are free and do a decent job of giving you real time quotes in a watch list and some also give you news feeds and charts, but they just don't cut the mustard if you are serious about your investments. PortfolioLive is different. It really does the job and although it does cost you $5.99 at the iTunes App Store, it is money well spent. I'd highly recommend it. Produced by Turing Studios, their programmers just know what they are doing.

There are 45,000 applications and counting for the iPhone and it is difficult to discern which ones are best for business news. There are a few freebies that are just outstanding not only in their news content but in the manner that the application is laid out. The ones I use the most and count on for up to the minute financial information are The New York Times, The Associated Press and Bloomberg. CNBC just released a new app for the iPhone with video feeds and portfolio tracking, but it is only in its first incarnation and needs some work. However, the video clips from the day's broadcast are a good bonus if you can't get to a television during the day.

What happens if you happen to be in the other camp and have a Blackberry? I have never owned a Blackberry, but I do know that TinyStocks offers StockManager for portfolio tracking on the Blackberry, Windows Mobile and the Palm operating system. I had a Palm Pilot years ago and used StockManager and thought it was a terrific application. Here is another group of programmers that know how to build an investing application.

Introduction

On July 10th the Dow Industrial Average hit 8,100, up from a multi-year low of 6,600 on March 6th. It was a nice 4 month run if you were long stocks and I thought it had run out of gas so I cashed out my positions and put some of the money to work in short positions. At that time I had $73,000 in a discount brokerage account and I invested approximately $49,500 in 685 shares of the ProShares Ultra Short S&P 500 Exchange Traded Fund (SDS) leaving me with $23,000 in cash. Three months later that $49,500 was almost cut in half as the DOW raced to 10,000.

A paper loss or a realized loss is easy to do when you are in leveraged ETF's which ProShares Ultra Short S&P 500 (SDS) is and the market is going up. With ProShares Ultra Short S&P 500, if the S&P 500 goes down 1%, you make 2%. If the S&P 500 goes up 1%, you lose 2%. It is very simple mathematics, but very risky if you are on the wrong side of the trade which I have been for three months now. This temporary loss has not has not soured me on my initial investment decision although my ego is bruised and I am subject to ridicule and embarrassment since I am making my investment decisions public here on the Internet. In fact, I recently put the remaining $23,000 of cash in my brokerage account to work in more short positions.

For the record, that $23,000 was used to purchase 280 more shares of the ProShares Ultra Short S&P 500 (SDS) and 1,000 shraes of the Direxion Small Cap Bear 3X Shares (TZA) which is leverages 300% to the downside of the Russel 2,000. All of the cash in my trading account is now in leveraged short positions because I firmly believe we are going to retest the lows we saw in March if not go lower in the next two years. As I write this, my cost basis for the ProShares Ultra Short S&P 500 (SDS) is $62.70/share and the Direxion Small Cap Bear 3X Shares (TZA) is $11.50/share.

The purpose of this Web site is to track the $73,000 invested in July over a three or four year period using whatever tools are available to a retail investor and see what happens to the money. In addition, it will be a forum for discussing investing and most specifically my philosophies on investing. I originally wanted to call this blog the do-it-yourself hedge fund, but that name has already been taken, but you get the drift. Anything goes. A note of caution, I have been investing for almost 20 years and tend to take outsize risks so what I am doing with my money is not recommended for most accounts. Three months after the beginning of this experiment my initial $73,000 is now $49,000, down 32%.