What do you do in downtrend markets?

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Despite the recent rebound in the equity markets, the global economic outlooks are still not in good shapes, with the Ukraine war ongoing, elevating inflation and central banks’ rate hikes. The US stock markets ended the worst first half in 50 years, with S&P 500 entering a bear market, down more than 20%. It is certainly a very hard time for those investors who are holding a bunch of losing positions. But panic selling usually leads to unnecessary losses once markets bounce back. There are some tools you could consider hedging the current losing positions.

CFD short sell

Contracts for difference (CFDs) are derivative products that enable you to trade on the price movement of underlying financial assets, which allows both buy and sell-side trades. In short, placing a sell position in a downtrend market can bring the same return as a buy trade in a market rally. For example, you can place a short sell trade for any shares that you are holding when they are plunging to hedge the running losses, which is the beauty when you have a CFD trading account. When the price falls, a short position will bring gains for the same amount as the falling prices.

However, this requires a personal decision regarding the proportion of your portfolio that needs to be hedged, and the timing when the hedging positions need to be closed. In a bear market, the short positions usually need to be closed toward the bottom. Sometimes, traders refer to option markets to decide the CFD closing prices. In addition, the leverage risk is also something that you need to manage when using a CFD account to avoid a margin call. 

The defensive instruments

If the risky assets account for a large percentage of your portfolio, you could also consider increasing the safe-haven assets to hedge the risks with your planned investment funds. The typical safe-haven asset is gold. Gold price usually goes up when there is a market crash or in an uncertain time. But it is not necessary to buy physical gold and keep them in storage as this could cause a high storage fee. The gold-related ETFs might be also options for low transaction fees and are easy to manage, such as SPDR Gold Shares (NYSEMKT: GLD) and iShares Gold Trust (NYSEMKT: IAU). As shown in the below chart, the gold holds its value when SPX 500 crashed in GFC, the US-China trade war, and Covid.  

Comparison between the SPDR Gold trust vs. SPX 500 since 2005

Source: Tradingveiw as of 8 July 2022 (Click to enlarge the chart)

In the stock markets, defensive sectors are usually more stable during market turbulence. The typical defensive stocks are in the utilities and consumer staples sectors as the businesses in these categories can usually endure an economic downfall better in terms of being consumer essentials. The ETFs you could consider are Utilities Select Sector SPDR Fund (XLU), Consumer Staples Select Sector SPDR Fund (XLP) and Healthcare Select Sector SPDR (XLV) The below chart illustrates that the three ETFs outperformed the SPX 500 with the least volatility year to date.

SPX 11 sectors performance YTD

Source: Tradingview as of 28, July 2022 (Click to enlarge the chart)

The CBOE Volatility Index (VIX) is also a good tool for investors to hedge market rout, which is the index to gauge the risks of the market. VIX surges when investors show concerns and worry, especially in a market crash. In history, VIX skyrocketed to above 80 in both March 2020, when a pandemic-induced selloff happens, and October 2008 during the GFC period. On the flip side, VIX is usually below 30 when the market sentiment is relatively calmer. It is also an indicator for investors to assess the market risks.

CBOE Volatility S&P 500 Index

Source: Tradingview as of on 28, July (Click to enlarge the chart)

The instruments to hedge long positions

There are some instruments providing the reverse trending against the mainstream stock markets too. These products are going inversely with the hedging instruments, such as PSQ or SQQQ to hedge QQQ, SH to hedge S&P 500, SARK to hedge ARK, and BetaShares BBOZ to hedge ASX. However, these EFTs are not buy-and-hold investment instruments, which are usually for one-day hedging purposes. Also, some of the reverse EFTs provide leverage in the pricing movement, in turn, increases risks when markets rebound. I have listed the most two popular hedging ETFs below.

ProShares Short QQQ ETF (PSQ) is an exchange-traded fund that tracks the inverse of the Nasdaq-100 index ETF (QQQ) daily. Further, ProShares UltraPro Short QQQ (SQQQ) is 3 times leveraged inverse ETF that tracks Nasdaq 100.

ProShares Short S&P500 (SH) goes inversely to the S&P 500, which is good to hedge a bear market on a daily basis. ProShares UltraPro Short S&P 500 ETF (SPXU) is times inverse of the S&P 500 performance, also for one day hedge.