As expected, the market sell off today was brutal and far reaching. The Dow Jones and the S&P were off 4.4% and 4.7% respectively, and according to the futures, the sell off will continue in tomorrow’s session as well. Some say “the trend is your friend”, and would advise you to just short the collapsing markets. But the turn around could be painful when the institutions pile on to pump up the shares and crush the shorts. And just when they see everyone covering, they are sure to pounce on the shares again and resume the painful sell off.


As the markets continue the downward trend, more and more people are piling into safer but lower return instruments such as bank CD’s and treasuries. For those who insist on staying in the game (Wall Street is the biggest and best poker game on earth), there is a simple strategy that all the best traders employ. It’s called “balanced trades” by most people. I call it the “hidden jewel in the shorts”.  As an aside, hidden Jewel is also a rock climbing term that signifies that secret and tiny finger pocket at a critical juncture of an otherwise blank and featureless wall.

The art of balanced trading refers to maintaining a healthy balance of both long and short positions.  My hidden jewel in the shorts implementation refers to shorting an index, while simultaneously going long a small portion of that index that is the best of the crop - the hidden jewel.

Consider the basic materials sector, which is under significant downward pressure of late.  Proshares offers an ultra short basic materials ETF (SMN), which attempts to produce a performance of twice the inverse performance of the basic materials sector.  The top five components of the sector are Monsanto, Freeport McMoRan copper and gold, Du Pont, Dow Chemical, and Praxair.  The ultra short fund acts as the short side, and the trick is to find the hidden jewel in that pack of shorts that will hold up better then the shorts, and balance out the combination trade.  It’s a completely subjective exercise, but assume for the moment that your hidden jewel is Dow Chemical (DOW).

At the beginning of the quarter on July 1st, SMN closed at 29.52 and DOW closed at 35.17.  Purchasing 100 shares of each would set you back a total of $6,467.  SMN acts as your downside protection (the “Shorts”) while DOW acts as the “Hidden Jewel”.  Taken together, the pair trade acts to maintain a little more stability in your account and reduce the overall volatility and price swings.  As of today, SMN closed at 44.93 and DOW closed at 35.14.  The combined position - “Hidden Jewel in the shorts strategy” - rose in value from $6,467 to $8,007, for a return of nearly 24% since July 1st.

Keep in mind that this is just one example of the strategy, and not a recommendation going forward.  But if you do insist on staying in the markets, and you are tired of the wild fluctuations or huge declines in your account, you may want to search out and find your own hidden jewel in the shorts.