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How to Hedge in a Negative Momentum Environment

by | Feb 23, 2023 | Market Outlook, Stocks

Dear Reader, 

NVIDIA (NVDA) may have stolen the headlines Thursday…

But the only rule is momentum. 

Today, the Dow Jones turned negative for the first time YTD as capital gushes out of the market. Yesterday, we witnessed a sucker’s rally, followed by an early squeeze. 

After sucking retail investors back into all of the fun junk stocks once again, funds started dumping all over again.

My indicator turned negative on Tuesday morning. Even though we witnessed some squeezes in the last 24 hours, conviction is what matters. 

We’re now starting to see serious concerns about rising interest rates, a recession, and the obliteration of the “no landing” narrative. 

With momentum negative, investors and traders alike need to know how to properly hedge this market. Let’s discuss those critical tools to save you money and protect your principle.

NVDA Is the New Cisco

Retail traders are buying up NVDA even though it trades at 133x earnings, 23x revenue, saw a 21% drop in revenue, and venture capital funding is really under pressure. 

Everyone keeps arguing that NVDA will dominate the world of AI startups in the future, as those companies will need to use the semiconductor giant’s chips. Okay… well, those startups get capital from venture capital companies. 

And venture capital fundraising has been terrible for six months. 

Do you see why I’m beating my head against the wall over this one?

NVDA is starting to trade with the same cult-Like approach to Tesla (TSLA) a few years ago. But it also feels very similar to Cisco (CSCO) back in 2001. 

Back then, any mention of networking and advanced internet delivery propelled CSCO’s valuation into the stratosphere. The problem is that the company had to eventually grow into that valuation while facing a recession. 

The stock has never come close to its Dot-Com high near $80.

Something tells me that NVDA will eventually run out of tricks. Two years ago, it would rely on cryptocurrency speculation to goose the stock. 

Yesterday, the company’s executive team mentioned Artificial Intelligence 75 times during its conference call. Eventually the magic will wear off.

Turning Negative

Markets stopped paying attention to NVDA at 10:40am this morning. Our outflow signal flashed red at that moment, and the S&P 500 took a nosedive. 

This is the second big signal in the last few days of funds using short-term pops to sell into strength. 

I remind traders that the market trend in weakening conditions is lower highs and lower lows. Any short-term squeeze is typically met with a wall of selling by larger institutions trying to get out of positions. 

Retail investors tend to get suckered into short-term, low-volume rallies. 

If you want to get a sense of how serious the buying is in the market, pay very close attention to the relative volume of the S&P 500 ETF (SPY) during the lighter trading hours of the day. 

Anything under 80% or 0.80 signals that the rally is due to machine buying and squeeze activity. Typically, those rallies are not sustainable. 

In this environment, it’s important that investors understand how to manage their portfolios. When momentum goes negative, there are a few different things that you can buy or trade to hedge against your portfolio positions. 

  1. Proshares S&P 500 Short ETF (SH): This ETF is an inverse ETF that trades at a -1 to 1 performance of the S&P 500. For every 1% that the S&P 500 falls, the SH will gain 1%. When S&P 500 selling picks up, I prefer to purchase an equal weighted stake of SH to my other positions in a long-term portfolio. I don’t want to sell my long-term positions, but I do want to hedge against a downturn. SH is relatively inexpensive, and it’s a tool that I just employed on my value and income portfolios at Tactical Wealth Investor.
  2. Options on the Proshares S&P 500 Short ETF (SH): There is an active options chain for this ETF. If you purchase the in-the-money call for the following month (March 17, 2023), you can replicate the performance of 100 shares of the ETF with a small amount of capital. The only difference is that it will require some ability to pay for time in the options chain. I don’t like to use spreads largely because it caps the potential upside of the trade.
  3. ProShares UltraPro Short S&P500 (SPXU): Finally, there is the high-octane trade. The SPXU is an inverse 3x ETF that makes 3% for every 1% that the SPX declines. This is a way to hedge against larger positions against much bigger declines that typically come from negative momentum events. I don’t like to own a lot of this, and I prefer to never hold it over the weekend. But it’s a very good tool for day traders and individuals who have a lot more risk tolerance in this market. 

Over at Tactical Wealth Investor, we don’t need to sell our stocks in a panic. Instead, we add our short-term negative hedge on the S&P 500 with an inverse ETF. At the same time, however, we also focus on companies that are very cheap based on academic metrics and provide inflation-beating dividends. 

In fact, while the market has sold off strongly since February 2, our top shipping player Pangaea Logistics (PANL) is up roughly 9%. And shares are up 21% since we added it to the portfolio.

To your wealth,

Garrett signature
Garrett Baldwin

Market Momentum is Red

Momentum was very negative today despite the mid-afternoon reversion. That said, with an ongoing weakness in the market, investors should steer clear of trying to buy the dip. Investors should continue to focus their attention on where value and income exists in this market. You can do so over at Tactical Wealth Investor.

WRITTEN BY<br>Garrett Baldwin

Garrett Baldwin

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