Bear Market Lessons: Own Bonds and Trade

02/20/2008 12:00 am EST

Focus: MARKETS

Doug Fabian

Editor, Successful ETF Investing, ETF Trader's Edge, Weekly ETF Report, and ETFU.com

Doug Fabian, editor of Making Money Alert, says an unusual combination of holding long-term bonds and trading stocks makes sense in the current bear market.

The Federal Reserve is trying to revive the economy by the only means at its disposal—a slash-and-burn policy on interest rates. So far, the stock market hasn't responded well to the Fed's actions.

In fact, ever since the proverbial line in the sand at about 1410 on the Standard & Poor’s 500 was breached, we've seen several attempts to get back above that territory—yet all such attempts have failed.

In my opinion this is because we are firmly entrenched in a bear market.

Right now, we are grappling with a nationwide housing bubble; a credit bust that went way beyond subprime mortgages, and a tapped-out consumer who has overspent and under saved for years.

If I am right and things in the equity markets continue to be bearish, what is an investor to do?

One area I am strongly recommending right now is bonds. Not just any bonds, but long-term US Treasury bonds.

These bonds do quite well in times of economic turmoil, as money shifts from risky investments to more stable investments. With long-term Treasuries, you get money-fund interest rates AND the potential for some really nice capital appreciation.

[Another] major upside to all of the volatility in the financial markets is that short-term trading opportunities abound.

The way I see it, it's time to be a trader, and there is simply no better vehicle than exchange traded funds (ETFs) when it comes to trading.

Of course, trading ETFs for short-term gains isn't always the easiest thing to do. So, to help you, I've jotted down a few rules that can help make your trading more profitable.

  1. Trade only a portion of your nest egg. I'd say you should limit your trading capital to 20%-30% of your total investable assets. You also should make sure this trading money is divided up into four or five different positions.
  2. Trade both on the long and the short side of the aisle. This volatile market allows you to make money when stocks go up AND when stocks go down. There are over 30 bear market ETFs today, and if you aren't acquainted with them by now you should be.
  3. Short the rallies. When stocks look like they are getting ready for a big move to the upside—like we witnessed a couple of weeks ago—that was your opportunity to get your trading money positioned on the short side.
  4. Seek short-term gains of 5%-10%. Don't get greedy. Try hitting singles and doubles rather than swinging for the home run.
  5. Set stop losses. Remember that if you are wrong it's okay, just as long as you only take small losses. It's those big losses that really hurt, so avoid them completely.

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