“The Paddle Strategy: Profiting in a Bear Market”

By Travis Johnson, Stock Gumshoe, January 24, 2008

Just wanted to share a few words about this teaser, mostly because I have gotten sooo many emails about this one.

Which is not a surprise, of course — it’s no coincidence that this email ad has been circulating heavily over the last couple weeks as investors have nervously been watching the market make wild moves, and investing pundits have been letting us all know that the sky is falling and the recession is coming (if it’s not already here).

I don’t know what the economy will be like in six months, or whether or not we’re in a recession. I don’t know if the housing market will recover this year, or next year, or in five years. I do know that most of the people making most of the specific predictions will be just as wrong as you or I would be. It is easy to see what the short term trend might be in the market, though even those guesses are often wrong, but it is very hard to tell when a bear market is going to lead to 20% losses versus 35% losses versus 17% losses, and when it will end — just as NBER often takes a year or two to confirm when the economy was technically in a recession, so bear markets are very hard to see the beginning and end of, whether you’re in the middle of one or not.

But on to the specifics — what does this teaser offer to sell us? It’s from Dan Amoss’ Strategic Short Report. I wrote about another teaser they sent out earlier this year, called the Santa Monica Technique, which was really more or less a broadly worded teaser about shorting the market with put options.

“This controversial and little-used “paddle strategy” once launched the family fortunes of a U.S. President… Last year, it made as much as $10.96 million per day for one astute investor… And it now stands behind the top three most profitable market moves in history… ”

Most investors who have any kind of broad experience at trading will recognize that this “paddle strategy” that they’re talking about is simply betting against the market — which can be done in a variety of ways.

The long stories in the email teaser about the many fortunes that have been made by those who bet on a falling market serve to get the greed impulse going, since who among us doesn’t want to make a fortune like Joseph Kennedy or George Soros, both of whom had some very large profits on a small number of short bets.

And the “paddle” imagery? I can only imagine that this comes from “up the creek without a …”, but it could be something more exciting. Either way, what they call it doesn’t make much difference.

But what do we do with that knowledge? It’s easy enough to say that when the market goes down, people who bet that it would go down make money. They’ve got to be selling more than just that idea.

And it appears they are — they’ve got some kind of proprietary trading strategy. Sound familiar? Yes, there are probably just as many “proprietary trading strategies” as there are entries in the phone book. Lots of them probably work some of the time.

Unfortunately, the teaser doesn’t go into much detail about the criteria they’re using to identify short candidates, so I don’t know that I can tell you just want it is they’re selling.

Actually, that’s not true — I can tell you what they’re selling: Fear. As we’ve noted before, most newsletter teasers rely heavily on the greed impulse to get subscribers to sign up quick for a great instant win idea. But when investors are as skittish as many of us seem to be today, sometimes you have to pull out the fear impulse, also known, on down days in the market, as the “you ain’t seen nothin’ yet” threat.

And if you’re anywhere near retirement, or worried about losing capital, the urge to do something, to act in the face of a declining market and feel like you’re helping your portfolio instead of watching it collapse, can be very strong indeed.

Of course, what many people do is notice that the Dow dropped 15% and sell everything, or move their retirement mutual funds into the money market fund option. Even though that can seem like the only thing you can do, it also essentially means that you’re “seling low” — which is the opposite of what long term investors want to do.

So a teaser like this, that promises an active solution to a falling market, can be extraordinarily compelling, which is probably why so many people have emailed me about it.

I don’t have any clear cut answers. I can tell you that if you can pick stocks that go up, you can also pick short candidates — the things to look for and the skill required to identify stocks are more or less the same on the short side as on the long side. If you’ve any experience at valuing stocks, you can pick those that are overvalued, and bet against them. Unfortunately, betting against the market is usually more expensive than betting with the market, so you have to be even more certain that you’re right.

And, as Keynes is famously quoted as saying, “The market can stay irrational longer than you can stay solvent.” So you can’t necessarily count on a market, even a bear market, accepting your more rational valuation and driving a stock or an index down by the amount you need to be profitable, or in the timeframe that works for the bet you have placed.

That said, I can’t sniff out what the “five part strategy” is for picking short candidates because not many clues were given for that. I expect that it’s the same kind of things that other short sellers look for: irrational valuations that assume an optimistic level of future growth, insider selling, high levels of debt or poor quality earnings or reported earnings that significantly exceed cash flow … and you could probably add more.

What I can tell you, for those who are not experienced at all with this stuff, is how to bet against the market if you’re so inclined.

The first way, and by far the simplest and lowest risk way, is by buying put options. This is just the flip side of call options — where call options give you the right to buy a stock at a determined price before a particular date, put options give you the right to sell a stock at a set price before a set date. Many stocks and most indexes have options contracts available for trade.

The second way, which applies only to indexes, is to buy a reverse or inverse ETF. This is a bit more dangerous than buying puts, because these complicated financial instruments haven’t been around that long and they use derivatives and sometimes heavy leverage to attain their goals. There are funds for many of the major indexes, and you can either choose a straight reverse return or a doubled reverse return. ProShares is the leader in this area, and they call them Short and Ultrashort funds — short ones move up exactly as much as the base index moves down, the ultrashort ones move twice as far. The reverse is also true — if the index goes up 5%, the short ETF goes down 5% and the ultrashort goes down 10%. You can review the list of available ones from Proshares here.

And the final common way to bet against the market is to sell short individual stocks or ETFs. This is the riskiest solution because it has, theoretically, the possibility for you to lose more than you invested. Selling short, for those who don’t know, entails borrowing shares from your broker (who borrows them from someone who has the shares in a margin account) and selling them at the market price. Like options trading, it’s something you’ll have to be approved for by your broker in most cases. Then you hope that the shares go down, and buy them back at a lower price to repay the loan. If the shares don’t go down, you can wait longer … but if they go up dramatically, you’re probably going to want to “cover” that short and buy them back, at a higher price, losing money.

The Strategic Short Report and Dan Amoss may well have lots of great ideas for short candidates for you — I don’t know anything about his track record. I do know that it appears from the teaser ad that he puts a lot of stock in following the big hedge funds and big short selling investors to see what they’re betting against. There might be something to that, since I hear constantly that short sellers have a reputation for being the most thorough researchers on Wall Street, and many of them are fairly aggressive in making sure that the rest of the world understands the downside of the companies they’re selling short.

And certainly most hedge funds sell short and many of them make a lot of money doing so, but do remember that the original idea of a “hedge” fund was an investment pool that would endeavor to have decent returns in all markets — “hedging” their bets by going both long and short the market to protect institutional money from big losses of capital. There are probably very few that will make outsize bets in either direction without protecting themselves with hedges, so while we hear about huge gains that some hedge funds and private gazillionaire investors make on large bets, keep in mind that even most professionals keep a tight hold on their risk and don’t make huge bets on either direction.

The flavor of the month in recent years, for an idea of how some folks manage short money, was the calculated 120/20 or 130/30 strategy, with both being ways to incorporate a level of shorting, so you would have 120% of your capital in long bets and 20% sold short in against-the-market bets, which has at times been described as a way for other managers to get hedge fund results. I won’t pretend to be an expert at this, either, though there are many folks who can provide educated descriptions of this, including a good article by Christopher Holt. Another common way of shorting to reduce some risk is called a “pair trade”, which identifies usually two companies in the same sector and lets you go long one and short another on the assumption that you don’t know which direction the sector will go, but you’re certain that one stock is better than it’s competitor regardless of the market’s move.

So … I won’t mutter on any more about this service — he didn’t tease any specific stocks that you can profitably bet against, so I can’t give you a specific idea, I can just provide a small amount of context. I personally almost never buy puts, and have no interest in ever using the other two short trading options. I can’t call short term market directions worth a damn, and I usually know enough not to try.

And while I often have ideas about stocks that “should” go down, those ideas are wrong as often as they’re right — probably more often, to be honest. Given the expense and risk of betting against stock movements, and the necessity to be fairly nimble if you’re making these bets in the short term, I’m happy to focus on finding good companies that I want to invest in and not waste my time finding bad companies to bet against. I also, to be clear, have a very long time horizon and I’m willing to sit through bear markets and wait it out, painful though that may be.

I do believe that going short the market and hedging your bets with puts are reasonable ideas, but I also think that it would help to have a level of sophisticated trading expertise to consistently do really well at either. If having 10% of your portfolio in protective puts or in an inverse fund makes you sleep better, though, more power to you.

Sorry to spin out another web of words that doesn’t end with a stock that you can research, but if there are short sellers or hedgers out there in Gumshoe Land who’d like to share their experiences, I’m sure we’d all be happy to hear.


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18 Comments on "“The Paddle Strategy: Profiting in a Bear Market”"

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Dividends4Life
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January 25, 2008 10:08 am

> I can tell you what they’re selling: Fear.

You are spot on with this statement. When it comes to investment products they all seem to be packaged in either fear or greed, depending on the current economic condition.

Best Wishes,
D4L

G IMBURG
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G IMBURG
January 25, 2008 1:03 pm
Short selling,like all trading, has inherent risks, but is basicaly no different than trading up. The biggest danger is volatility as were seeing now. Its not predictable and the risk of loss is high. If you have the stomach for it{I DO},learn to hedge your positions,otherwise you may be eaten alive. One famous investor/trader said dont trade unless the position is so obvious it is waiting to be scooped up. The subprime mess would be an obvious choice to have shorted last summer and is an example of Jim Rogers advice. How much would you have made had you shorted… Read more »
Ed McNamara
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January 25, 2008 1:50 pm

Great recap of “paddle strategy”! The ProShares attachment was an added bonus!!!
Eddie Mac

Fritz
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Fritz
January 25, 2008 2:05 pm

I don’t quite understand why the Gumshoe is so skeptical about newsletters…it is a good value to pay $49 a year for True Wealth or $99 a year for the Oxford Club, and get a lot of good investment advice, especially if you have a full-time job and don’t have a strong financial background to do a lot of heavy stock analysis (as the Gumshoe seemingly does). It’s a hell of lot better than trying to pick stocks on your own, or paying some sharky financial advisor to do it. I’m just sayin.

RICKO
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RICKO
January 25, 2008 2:09 pm

TO G. IMBURG, WHEN SHORTING YOU HAVE LIMITED UPSIDE, “0”. THERE IS NO LIMIT ON THE UPSIDE GOING LONG.

Trfenwyd
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Trfenwyd
January 25, 2008 2:19 pm
Fritz, Obviously this website is not for you. If you want the newsletters, go ahead and purchase them. But don’t be surprised when the touted performance you based your buying decision on turns out to be nothing more than a “past performance is not indicative of future performance” disclaimer. I found this website while researching a thing called 801k’s. It saved me a lot of money. I wish I would’ve found it before I subscribed to a couple of newsletters. It would’ve saved me more. This website is for those who’s inboxes are flooded with these offers, and only know… Read more »
Gravity Switch
Admin
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January 25, 2008 3:24 pm
Hi Fritz — I’m no more skeptical about newsletters than I am about financial magazines or newspapers, or tip sheets, or websites of any kind (including my own). I merely think it’s a good idea for people to decide which newsletters to subscribe to (if any) based on an understanding of what they recommend and a verifiable track record of some kind — not because of the excitement that a “top secret” teaser ad might engender in some people. I hope that defusing some of the mania that the ad copywriters build up can, every now and then, help people… Read more »
phyl ulmer
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phyl ulmer
January 25, 2008 4:18 pm

I find your articles very timely. Whenever I get a new teaser newsletter, I often find you are already addressing in your article.

Mosby
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Mosby
January 25, 2008 7:27 pm
I have been searching out teasers for a long time. I must admit, since I have found you, I’ve fallen down on the job. Time really is a premium, and I am not speaking just for myself. I know how much time I had put in, just to come up with a stock that I didn’t think worth buying,came up with a few goodies though. I think your recommended price of $4.50 is a STEAL. I certainly hope that you have many subscribers. You deserve more than to just cover your expenses. Keep up the good work. Expect a check… Read more »
Fred G.
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Fred G.
January 25, 2008 7:43 pm
Gumshoe….there is little new regarding investing, we are witnessing the blow off of the Fed created bubbles,horrific government spending, and consumer irresponsibility mutiplied by both fear and greed, all to fleece the unitiated who are too lazy to learn that only they can really manage their investments. The “paddle strategy” is problematic to me, it reeks of Indian curry. My guess is that this cumin seed is describing the old “butterffy option strategy” which can not be easily executed these days, and uses his magic box to indentify stuff breaking through it’s moving averages, whatever his definition of time frame… Read more »
Sniper
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Sniper
January 25, 2008 9:31 pm

Fritz,
I am a former subscriber to Oxford Club, Daily Wealth, Green Stocks, and a number of other newsletters. After years of bogus recommendations and being inundated with teaser ads, I finally stumbled upon Stock Gumshoe while researching, cancelled all my subscriptions, sent in a payment to Gumshoe, and have saved myself
a considerable amount of time and money by letting SG do all the sleuthing for me. I strongly suggest you do the same.

FlyHi
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FlyHi
January 26, 2008 7:27 pm
Hey, Gumshoe et al. I’ve bought a number of newsletters over the years, some of which have provided excellent advice and some of which haven’t. The newsletters themselves are generally not that bad, and some can be very educational and sometimes quite profitable. The thing that bothers me most about them is the incessant ads. If you subscribe to one, you get a zillion ads for more, and eventually it’s all the email you seem to get! The onslaught of FEAR- (and greed-)MONGERING is enough to keep one superhyped and upset! In general, though, I agree with Fritz that the… Read more »
James
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James
January 26, 2008 8:06 pm

Hey! I like what the gumshoe is doing so much that i sent him 50.00. I put ” my money where my mouth is”. It is rare to find someone who is objectively sharing their knowledge, and his ability to write clearly. So make sure that you aren’t paddling down the stream when you should be paddling up the stream.

Thanks Gumshoe for all you do.

NEIL
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NEIL
August 17, 2008 4:25 pm
i subscribed to the short report (“paddle strategy”) … dan’s advice has been pretty good but at least half of it i was onto *** well before dan suggested it *** … here are the obvious ones (1) LEH … that was on the yahoo newsgroups as the next to go as soon as bear sterns tanked .. dan suggested it weeks later … (2) MBIA .. well duh , when dan nominated it even cnbc had been going on about it for weeks!! (3) PNC … i had puts on that and bailed at the mid fifties based on… Read more »
Scorp1107
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Scorp1107
September 15, 2008 2:13 pm

GUM : Your the best, saving me time and money.

Thanks AGAIN !

Oliver Vandagriff
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October 10, 2008 9:32 am

Read up on options trading. both CBOT and Lind-Waldock have “knowledge centers”, and there are hundreds of hits in Google about options in stocks and futures. I read, I study, I buy call and put options. Made $20,000 profit last month. You don’t need some financial newsletters to do this – information is available everywhere on Internet. Get informed and get a method – don’t trade emotional, only based on info. My picks: Gold is going up again and crude oil has to – sooner or later. The dollar peaked and will start falling now. Good luck.

farley 5
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farley 5
October 10, 2008 2:39 pm

US Dollar has a long way to go. I alerted SGS readers a bit early in May. Take a peek:

http://stockcharts.com/def/servlet/SC.pnf?chart=$USD,PLUADANRBO%5BPA%5D%5BD%5D%5BF1!3!.5!!2!20]&pref=G

Pinkpanther
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Pinkpanther
October 13, 2008 5:58 am

Wrong Chart, use $USD not USD (UltraShares Semicond.)

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