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Holding: CAKE

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Symbol	Sector	Return	Exposure	Trades	Last Trade	Status
CAKE	Restaurants and Bars	4.18%	n/a	6	23-Jul-09	Prior Holding

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22-Jun-09

Short Picks, Including Ultra ETFs

Holding Rationale for CAKE.

I wanted to talk a bit about strategies for trading ultra ETFs. For the most part, I trade the ultras sparingly, and the 3x ultras not at all. I have not traded them effectively in the past, providing one reason for my avoidance. More importantly, the ultra ETFs frequently fail to track their intended target effectively, making it technical analysis less predictable. This will not be a revelation for many traders, but it is worth considering at this possible market top. Robert Zingale explains:

The problem with these Ultra ETFs is that their long-term performance will diverge from the underlying performance of the index that they track. The reason for this divergence is the fund’s use of leverage and volatility in the underlying index. The leverage used in the funds successfully allows them to track the daily price movements of the indexes that they are supposed to track, but leverage will also play against them over multiple periods if the index is extremely volatile.

As Zingale mentions, the ultra ETFs have a downward bias due to these leverage factors. To illustrate, let's take a look at the chart for SRS, with IYR superimposed:

As you can see, both the long real estate ETF and the ultrashort real estate ETF are down significantly during the last 52 weeks. At certain market stages, I want to gain the extra potential returns provided by ultra ETFs, particularly when a top or a bottom is likely. Instead of going long SRS, I have chosen to short URE, as I mentioned this morning. Similarly, this afternoon, I shorted UCC, the consumer services ultra long ETF. While I may not have the potential upside (going long an ultra can provide 100%+ return, going short cannot), I consider shorting a more predictable play, and the potential returns adequate.

This morning I also mentioned that the financials were at an important crossroads. Today XLF dropped below the 50 day moving average, indicating further downside ahead. The broader market will have trouble with a weak financial sector.

Today I went to the Motley Fool CAPS site, and did a screen for 1 and 2 star stocks up over 200% in the last year, providing me with some good short candidates. I consider the bullish mania for automotive stocks and restaurants during the past few months to be cases of misplaced enthusiasm. Beware that if too many people move short too quickly, we could get a oversold short squeeze at any time.

Here are some charts:

- DTG

- PFG

- LNC

- AN

- CAKE

- WYN

- EAT

- ENOC

- GT

- NSIT

- SFY

- TMRK

- TNS

- VPRT

Some Brazilian tunes for your Monday evening: