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The marriage of ETFs and passive investing, the current hot trend everyone's talking about, isn't a match made in heaven.
In fact, friction between the two is so huge, a divorce could crash markets irreparably.
On their own, both buying into ETFs and investing passively make sense. But loading up passive investing portfolios with ETFs – especially benchmark and market index following ETFs, which are precisely what passive investing calls for – is the equivalent of rubbing two sticks together over a mountain of dry kindling.
I've given you the numbers on how big ETFs have become and how hot passive investing is getting. And, to the chagrin of ETF sponsors and regulators, I've unpacked the truth for you about how ETFs are created and destroyed and how the market professionals with the inside track on trading ETF shares alongside the underlying securities they're made from are self-serving.
Keep Your Profits When You Have Them
No one knows when the next big market selloff is coming.
If we did, we'd already be protecting ourselves by selling positions and shorting the market to make a ton of money on the fallout.
For the rapidly-growing passive investing crowd, the new crusaders and millions of former mutual fund investors who think there's a new foolproof way to invest, the fact that markets go down may not be so worrisome. That's because they think passive investing is some kind of miracle investing scheme that always makes money because fallen markets will rise again and, lately, seem to continue making new higher highs.
Mutual fund investors were lured into parking trillions of dollars in fund families based on essentially the same premise. They now know better.
When the next market selloff comes – and it's coming – passive investors are going to get hit hard with the reality of markets.
The pain investors feel when they see their life savings dwindling before their eyes hasn't changed.
Passive investors will become active sellers, especially if the initial selloff is unexpected (which it has to be at this point in the up-cycle), steep, and front page news… Not just in the financial press.
That's when the marriage of ETFs and passive investing strategies will start to burn the masses.
When the ETF shares start being sold, it forces authorized participants to sell underlying shares. But they'll also short the underlying and ETF shares to both hedge themselves and, more importantly, to make a ton of money pushing markets down hard and fast. That will shake passive investors to the core and beget more ETF selling.
Here's how to protect yourself.
Since it's impossible to time the moment when a selloff is going to turn into a full-fledged rout, panic, or outright crash, my number one rule for protecting any money exposed to m…
About the Author
Shah Gilani is the Event Trading Specialist for Money Map Press. In Zenith Trading Circle Shah reveals the worst companies in the markets - right from his coveted Bankruptcy Almanac - and how readers can trade them over and over again for huge gains. He also writes our most talked-about publication, Wall Street Insights & Indictments, where he reveals how Wall Street's high-stakes game is really played.