This from Investor’s Daily Edge:

A little over a week ago, in my Monday column, I correctly predicted that the December Housing Starts and Building Permits reports would miss the mark by a wide margin. I even correctly picked the actual number. This past Monday, my prediction was that the December Existing Home Sales report would also likely disappoint. I wasn’t such a good fortune teller the second time around.

The December Existing Home Sales report actually surprised to the upside, posting a gain of 6.5 percent versus November. This equates to roughly 290,000 units.

It turns out that I just underestimated how bad the housing market is. These sales aren’t from eager buyers who got priced out of the market during the run up over the last few years. The buyers are vultures, swooping in and cleaning the carcass. Over 45 percent of the sales were “distressed” according to the report.

That is bad news for the market. It is just the beginning of a viscous cycle.

Foreclosures continue to drive down prices in all markets. As a result, more and more homeowners see their equity vanishing. Many more find themselves underwater. This leads many to simply throw in the towel and let their own home go into foreclosure, feeding the cycle.

Another item to consider is whether or not all the bank-owned foreclosures are even back on the market yet. There is growing evidence that banks are holding back properties from being re-listed to avoid flooding the market, which would result in prices being driven down below what they hope to get for the repossessed homes. This means there could be an additional backlog of properties that we aren’t even aware of yet. This will delay any recovery.

Finally, a major question that needs to be answered is how many people actually qualify to buy a home? Fannie and Freddie are said to be toughening up on standards, and banks are just flat out not lending. That means short of a huge down payment or an all-cash purchase, buying any home, foreclosure or not is going to be difficult. And the housing market needs buyers to move the inventory.

With all this gloom in the market, it is going to take quite some time for a recovery. That leaves you plenty of time to profit from the slide in the housing market. One way is shorting the iShares Real Estate Index (NYSE:IYR), another is shorting the Vanguard REIT ETF (NYSE:VNQ). Both have already seen a significant down leg, but with the housing market the way it is, there is still plenty of room to the down side.

A more speculative play could be the UltraShort Real Estate ProShares (NYSE:SRS). This ETF moves inverse to real estate, so it goes up as the market goes down. A quick look at the chart shows a huge spike in November and a drop since then. It is now trading at two-year lows, so you could view it as a more speculative play on the continuing decline of the housing market.

Source: There Is Still Money To Be Made In The Housing Market

He says it is essential to guard against today’s downside risks with trailing stops, inverse ETFs, and put options.

And every investor should have a plan to re-engage with the markets when this financial storm passes.

This from Money Morning:

As the worst financial crisis in recorded market history rocks Wall Street, millions of investors on Main Street keep asking a single question.

When will this end?

The market volatility is unprecedented: Where professional traders once ranked a day as “wild” if we witnessed a 300-point swing, in recent months we’ve seen 600- and 700-point swings on a regular basis. On Oct. 9, a Thursday, we rode out a record-setting swing of 1,000 points.

That wild backdrop is bad enough. At the same time, however, the major market indices are heading lower – at times with a speed and ferocity never before seen. But the real killer is that there is seemingly nowhere to hide.

This is what Wall Street’s Armani Army doesn’t tell you about traditional diversification: It doesn’t work when everything goes down at once. (The one exception is the specialized inverse investment vehicles that we’ve repeatedly counseled you to employ precisely to prevent this kind of total freefall. Two examples that we’ve mentioned numerous times were the Rydex Inverse S&P 500 Strategy Fund (MUTF:RYURX) and the ultra-aggressive “2X” ProShares UltraShort Financials (AMEX:SKF) exchange-traded funds).

Most noticeably, of course, was last Friday’s trading, which began after an overnight bloodbath in the markets overseas. A notice from the CME Group Inc. (CME) that stock index futures contracts were “limit down” – meaning they’d achieved their maximum allowable downward move for U.S. stocks even started trading for the day – didn’t help much.

While much of this is commonly explained away as a panic reaction to the news, the reality is that it’s primarily a financial panic that’s driving this market action lately. And, just in case you recall my comments a few weeks ago about not having seen the hair on fire selling I thought lay ahead, this is exactly what I was referring to.

This time around, ironically, it’s not panic from normally flighty retail investors that’s causing the markets to go haywire. Instead, it’s the big boys that are apparently panicking.

My experience suggests that one or more hedge funds have imploded. Whether by margin call or redemption proceedings is a moot point. We won’t know for sure until much later next week when the newspapers finally catch up, but the massive swings we saw in currencies, gold and other commodities are certainly consistent with an unprecedented liquidation – and a forced one at that. Perhaps even more than one.

Long the domain of hedge funds and their uber rich clientele, many hedge funds were over-weighted in these categories in recent months in an attempt to chase performance. Overweighting, in case you’re not familiar with the term, means they’ve made excess investments in those areas. And chasing performance means they’re trying to create higher returns by making disproportionately larger bets than they would otherwise. Part of this could be from simply trying to generate larger performance fees, but it could just as easily be attributed to anxious managers placing ever-larger bets in an attempt to make up losses (most hedge funds are under water this year).

Where this gets fund managers in trouble is when they make these over-weighted bets by using leverage. You’ve probably heard this term a lot lately. In case you don’t understand what it really means, let me digress for a moment to explain it. Leveraging up (or simply “levering” to those in the industry) means using borrowed money to control a huge pile of assets that you wouldn’t otherwise be able to control.

In recent years, for instance, it wasn’t unusual for a hedge fund to lever up 30 to 1, meaning for every $1 dollar they invested they borrowed $29. As a result, a fund with $100 million under management could control $300 million or more of investable assets. I’ve heard of some funds running 50 to 1, while currency traders routinely run 100 to 1.

While using other people’s money dramatically enhances the potential for higher returns, it really enhances the potential for massive losses. Where this gets them into trouble is that a fund running 30 to 1 only has to lose 3% of the $30 worth of equity to get wiped out, as in kaput.

Somewhere along the way, as bad turns to worse and performance deteriorates, a hedge fund’s creditors will place a margin call, meaning they want the hedge fund to pony up more collateral or return the money it was loaned. Or, investors will place redemption requests meaning they want out. Either way, this forces the operator of a hedge fund to raise money any way it can.

If a given hedge fund does not have enough cash to meet the margin calls or redemption requests, they have to raise cash by selling assets. And they typically start with the most liquid stuff like gold, currencies and commodities. At first, the sales progression will be orderly, but as I suspect was the case last Friday (and on many big down days recently where chaos ruled), it will rapidly deteriorate into a fire sale where the hedge funds involved dump everything they can at any price just to get out.

And that’s where their problems affect you and me.

As scores of highly leveraged hedge funds dump billions of dollars worth of holdings at once, they effectively “flood” the markets with whatever the asset is that they are trying to sell. In doing so, they push the values down for the rest of us.

For an example, imagine a house in your neighborhood selling for 50% of its appraised value. Upon completion of the sale, all “comparables” in the area, including your own home, will likely take a hit as a result. So it’s in everybody’s interest to keep prices as high as possible.

But nobody can do that when there are more homes than buyers – even in the best neighborhoods.
So when is it going to stop?

We don’t know. No one does. Hedge funds are notoriously secretive in their reporting, so even though there are estimates as to how much they own and (by implication) how much they owe, it’s hard to gain perspective on how much leverage is actually being used. Nor do we really know who holds what asset – especially as it relates to potential liquidations.

Over the weekend, rumors were flying that U.S. Federal Reserve examiners are hounding Citadel Investment Group LLC regarding “counterparty risk” and its exposure to debt. Citadel, naturally, vehemently denies this, but lately where there’s smoke, there’s certainly been the potential for fire.

[...] The bottom line is this: What should we do for now?

That’s actually the easy part even though it may not feel like it.

1. If you’re retired, take a good hard look at how much money you really need for the next five to 10 years. Talk to your financial advisor and, if needed, take some risk off the table. Move what you need into cash, or such safety-first choices like the American Century Capital Preservation Fund (MUTF:CPFXX). Do not own anything you would not want to have in your portfolio if the stock markets were to be shut down for a short time.

2. If you’re not retired – but are close – and have properly diversified your money to something akin to the 50-40-10 structure we advocate (50% base-builders, 40% global growth and income, 10% speculative), hang in there. And remember, this is exactly why we diversified our holdings in the first place – to get through the rough spots. It’s just that this is perhaps the roughest most of us have ever seen.

3. Stick to your plan. Hopefully that includes the disciplined use of trailing stops to capture gains and minimize losses, as well as specialized inverse holdings that profit with each further decline. And don’t forget options to hedge existing risks.

4. Above all else, make sure you have a plan – as we do – for re-engaging the markets when the coast is all clear. It may be awhile before we reach that point, but it’s important to maintain your upside potential in a down market. When the train leaves the station, the one place you don’t want to be is left behind on the platform. Studies like those from Standard & Poor’s show that investors can typically make up 80% or more of bear market losses within the first year of a recovery, once that recovery actually arrives.

Source: Four Ways to Sidestep the Damage Wall Street’s Big Money Movers are Inflicting on Main Street