When I examine a one-year chart of the SPDR S&P 500 ETF (SPY), I am reminded of why I try to avoid using inverse ETFs in my client accounts. There were several instances of 2% to 5% pullbacks in 2013 that ended up being buying opportunities rather than shorting opportunities.
In addition, if you were not careful to put a tight stop loss on your inverse trade, you were probably quickly stung for double-digit losses. Those types of mistakes can hinder your total portfolio performance even during a stellar year like 2013.
Some Guidelines to Follow for Shorting the Market
- Make sure that you are using a tight trailing stop loss whenever you are entering a short position. A small loss is much easier to make up for than a big loss that can set you back months.
- Shorten your time frame when using leverage or inverse positions. Instead of months or quarters, you should be thinking in terms of days or weeks for entering and exiting positions. Stay nimble and take profits when possible.
- Use smaller position sizes when you are shorting the market as a way to limit your exposure. Your allocation size will determine how much you are willing to risk.
- Remember to stay as balanced and unemotional as possible when shorting the market. Don't get overly confident when things go your way or too depressed when they don't. Keeping your emotional capital -- confidence -- intact is just as important as preserving your investment capital.
At the time of publication the author had no position in any of the stocks mentioned.
This article was written by an independent contributor, separate from TheStreet's regular news coverage.
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