“The type of man she hated… was the type she wanted.”

 That’s a tagline from the 1946 classic film noir movie The Big Sleep, starring Humphrey Bogart and Lauren Bacall.

As a former film student at school, the movie popped into my head while I was on my way to the office this morning, as I was thinking of metaphors to sum up the current state of the stock market. And since the title of the film is a euphemism for “death,” it seems appropriate, given that the recent wild fluctuations have put many investors’ portfolios to sleep – and outright killed many others.

I’m going to use a little poetic license here and apply that tagline to investing instead: “The type of market investors hated… was the type they wanted.”

Yes, that’s right. Far from joining the masses in a frenzy of fear and panic, let’s take a “smarter” approach to this situation and actually use the downward trend for us, not against us. There are a few quick and simple strategies you can employ in order to fight back against this meltdown…

That Dreaded “R” Word Is Back Again

“The market is very worried about a severe international economic downturn.” That’s the verdict of commodity strategist David Moore at the Commonwealth Bank of Australia.

He was speaking the day after the Dow endured its second-worst one-day slump in history (733 points), with stocks losing a staggering $1.1 trillion in value. The index has recorded triple-digit movement on 20 of the past 23 days and posted just one positive day this month. The Associated Press says investors have lost $8.3 trillion from 401(k) plans, pension funds, college savings accounts, and other investments.

Sure, September’s consumer price inflation reading came in flat, compared with August. But it doesn’t disguise the fact that U.S. employers are shedding jobs en masse, while retail sales dropped 1.2% in September. On the bright side, though, this has led to oil prices dropping by more than 50% since July’s $147 record high. The black goo currently trades at a 14-month low around $70 a barrel amid speculation that consumption will drop as consumers cut back and a global economic recession takes hold.

While there’s nothing you or I can do about a recession, there are steps we can take to combat the stock market’s nosedive. Let me take you back to my colleague Marc Lichtenfeld’s “Five-Point Bear Plan” that he published here back in August 2007. What was true then is even truer today…

Your Five-Point Bear Plan

1. Sell Short: This is when you sell a stock before you own it and buy it back later. The premise is that you expect to sell high and buy low, in that order. But you need to borrow shares first in order to be able to sell them. And of course, the risk is that a stock can go infinitely higher. Your broker must also approve you before you can sell short.
2. Buy Put Options: You can buy put options on a stock or index that you expect to decline. This gives you the right to sell the asset to the seller of the option at a specific price in a pre-specified time. To do so, you must buy a certain number of options contracts – with 100 underlying shares equivalent to one contract. For example, if you think that American Express (NYSE: AXP) is going to decline, you can buy the November $20 puts. This gives you the right to sell the stock at $20 anytime before the third Friday in November, no matter where the stock is trading. If the stock heads lower, your put options should increase in value. Conversely, if the stock is trading above $20, your put expires worthless.
3. Sell Call Options: If you own shares that you don’t want to sell, but think the price may fall, you can sell call options against them. This gives the buyer the right to “call away” your shares at a specific price. Let’s say you own shares of Apple (Nasdaq: AAPL). You can sell the January $90 calls for $19, meaning the buyer has the right to buy your shares for $90 any time before the third Friday in January. No matter if AAPL is trading at $100 at that time, you’ll still be forced to sell at $90. However, if the stock is below $90, the option expires worthless and you keep the $19. You must be approved to trade options if you want to do this.
4. Bear Mutual Funds: There are several mutual funds that seek to profit when markets go down. They include the Prudent Bear Fund (BEARX), ProFunds Bear (BRPIX) and Rydex Inverse S&P 500 Strategy (RYURX). Be sure to read their prospectuses and holdings carefully before you take a position. You’ll also be required to invest a minimum amount and pay annual maintenance fees.
5. Bear ETFs: If you don’t want to short stocks or indexes, don’t have approval to trade options, or don’t want to pay the higher fees associated with funds, you can buy ETFs (Exchange-Traded Funds) that short various indexes instead. For example, the Short QQQ ProShares (AMEX: PSQ) seeks returns that correspond to the inverse of the Nasdaq 100. In other words, if the Nasdaq 100 declines 10%, PSQ should be up roughly 10%. There are also various bear ETFs, including sector specific and leveraged funds such as the UltraShort Oil & Gas ProShares (AMEX: DUG). This fund seeks returns that equal twice the inverse performance of the Dow Jones Oil and Gas Index.

(Please note: The companies/funds mentioned above are not actual recommendations, just examples).

Buff Up In A Rough Market

The bottom line here is that you shouldn’t just run off with the crowd and sell off, because that’s what they’re doing. Take a page out of Warren Buffett’s book instead.

Granted, the guy can afford to lose a few dollars here and there, but his investment philosophy is the important thing: He doesn’t cave into uncertainty, fear, or panic. He just rides out the market’s fluctuations and, in fact, rather than selling off, he uses downtimes as an opportunity to accumulate his positions for a discount. 

And that’s what has helped make him one of the world’s most successful investors.

By coincidence, Marc just e-mailed me the first part of his next Xcelerated Profits Report article, which ties into this perfectly. He says:

“Market slides like the one we’re experiencing give us an opportunity to get into great stocks at prices we could only have dreamed of just a few weeks earlier. Yes, it’s tough to buy while everyone is selling, but history shows us the most money is made by buying into a panic.

“I’m not suggesting we just blindly throw our money at the market. But the selloff is providing us with an opportunity to get involved with biotech – and I can’t think of a sector I’d rather be in than biotech right now. No matter what the economy has in store for us, people are going to continue to take the medicines that fight their illnesses. And this month, I’ve got two recommendations that have me salivating…”

Out of fairness to our paying subscribers, I can’t reveal those picks to you here. But if you act fast, you can get yourself on our list in time to receive them in the upcoming issue. It costs just $49.50 for a 12-month subscription and each issue is guaranteed to contain not only specific recommendations, but also the sophisticated, professional strategies that will elevate you above the crowd and allow you to make more money more safely and in a faster time. Check it out here.

Best regards,

Martin Denholm
Smart Profits Report