"An Approach to Successful Stock Trading Combining Company
  Fundamentals with Chart Technicals"

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07/27/12 ...  Hedging with Inverse Funds

Here's an example of how one might hedge the coming bear market (read Harry Dent's "The Great Crash Ahead")..  Six stocks that would be expected to hold up well in such a down turn (DG, WMT, MCD, WPI, UNH and PM) are combined with six liquid inverse ETFs (RWM, SH, EUM, EFZ, PSQ and SEF) in a 100 percent hedge strategy. Note, fewer inverse funds would have reduced the degree of hedge, while double and triple inverse funds could increase it, i.e., 6 long stocks combined with three double inverse funds would be completely hedged, e.g., SDS bears a 2x inverse relationship to SPY, SH a 1x inverse relationship.

Each of the above 12 have hypothetically been invested with $10,000 on 01/01/2011. The solid red line tracks the growth of the hedged group; the green line its polynomial fit; and the broken red line its percent return for the year (19.7 vs 8.0% for the S&P).  The solid blue line similarly tracks the S&P, the yellow line its polynomial fit, and the broken line its return.  Clearly, this hedged grouping has not only outperformed but also has experienced less volatility.  The maximum drawdown (peak price to following low) for the hedged portfolio was -5.1%, while that for the S&P has been -19.4% over this time frame. Note, another advantage offered by this type hedge is that all the trades are long, so the strategy can be used in in IRA account.

When the market is climbing, like it has been between Nov '11 and Apr '12, a hedged position suffers in relation to it.  Too, the long position in the hedge would be better served by changing the long positions to current TSM top picks rather than letting our initial ones ride. As the market turns bullish, especially in the good seven months of the year, it's better to put on less of a hedge--say 20 percent instead of the 100 percent used in this example.  Good return with minimal drawdown!