Wednesday, May 27, 2009

Make Money in Any Market

The market was down significantly today, almost 2%.  Despite this my portfolio was up about 1%.  Now you might think that is because I am short the market but that would not be the whole story.  I made money yesterday when the market was up by almost 2%.  Now I did not make as much money as the market but I also did not give anything back today.  One of the secrets that Warren Buffet always uses is to not lose money.  In a market like this one, it can be hard to do because of how it is whip-sawing back and forth.

I am achieving this through a very specific strategy.  I am pairs-trading.  This strategy is relatively simple.  You go long of one thing and short of another.  For example.  Say you are bullish on Broadcom.  You would like to buy it but it has had a pretty good run the last three months running up more than 50% in that time period.  To do a pairs trade you can buy Broadcom and go short of a broader index like the Nasdaq or the Semi-conductor index (SMH)  Why would you do this?  You are taking the market risk out of your stock purchase.  Stocks move up and down for any number of reasons.  Only half of a stock's price has anything to do with the actual company itself.  The other half is related to the broader market and the sector.  You are betting that the thing that you buy will outperform its peers but hedging yourself in case the market does crazy things.

I am short of the Dow, the real estate sector, and U.S. Treasuries while being long China, Materials, and a bunch of individual stocks.  This on a whole has performed quite well.  I've lost some money on my short positions since the market has continued to rally, but my long positions have more than carried me up.  Could I have made more money if I wasn't short?  Sure.  But the hedges have kept me sane by limiting my gains and more importantly limiting my losses.

I continue to use this strategy to great effect.  I think we are about to have another leg lower from here, there is weakness in the market right now and that is pretty evident.  I would like to get more short of the  market but won't get too crazy right now as I can easily be wrong.

1 comment:

  1. My dad advised me to stay out of China. I should have listened to my instincts!