A Better Way to Trade Emerging Industries

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This year has been especially rough for companies in emerging industries. Solar stocks have been hammered, battery makers are on life support, and even once high-flying Internet IPOs are floundering.

Since I'm an investor in emerging industries, that means my portfolio has been hit especially hard in 2011. But sometimes we can learn more from our failures than our successes. In this case, I think I've found a better way to invest in emerging industries, one that I'll start employing in the future.

The best vs. the rest
One of the advantages of being a writer is that my thoughts are recorded, and I can go back and look at what I got right and what I got wrong. Looking back at 2011, I found that my top picks in emerging industries had a habit of losing money for me. But the stocks that I thought were complete dogs in the same industries did even worse.

In retrospect, I wasn't wrong about which stocks were the best. I was wrong about the direction of the industry's stocks as a whole.

Take my solar picks, for example. For over a year, SunPower (NAS: SPWR) has been my top pick, with First Solar (NAS: FSLR) being a close second. Neither company has done well this year on the market, as you can see below. But on May 18, when I picked three clean energy stocks on their last legs, I picked two solar companies that performed even worse. Energy Conversion Devices is now a penny stock, and Evergreen Solar has since declared bankruptcy.

SunPower(48.3%)
First Solar(63.1%)
Energy Conversion Devices(92.1%)
Evergreen Solar(99.1%)

Source: Yahoo! Finance.

Had I taken a long position in SunPower or First Solar and offset it with a short position in Energy Conversion Devices or Evergreen Solar, I would have made money.

Rinse and repeat
A similar story played out in battery stocks, where I realized that Valence Technology was a much better pick than competitorsA123 Systems (NAS: AONE) or Ener1. In fact, Ener1 happened to be the third company I thought was on its last legs in May.

Valence Technology(47.6%)
A123 Systems                                       (77.6%)
Ener1(97.6%)

Source: Yahoo! Finance.

Again, none of these companies performed well, but a long position in Valence Technology along with a short position in either of the others would have been profitable this year.

Since it's rare for every company to survive as industries emerge, it makes sense to take long positions in the best companies and short positions in the weakest companies. This will lessen gains if the entire industry takes off, but it will also minimize losses if the industry as a whole takes a downturn, as we saw with solar and battery makers this year.

Who are the best and the rest now?
Right now, I am looking to the solar market as an emerging industry that provides some attractive long/short strategies for investors. But with SunPower and First Solar playing by different rules in the U.S. than manufacturers in China, I would like to keep my investments on a level playing field.

If we confine the list to Chinese stocks, I see Trina Solar (NYS: TSL) and Yingli Green Energy (NYS: YGE) as two relative winners in the Chinese solar market. On the flip side, I see nothing but bad news coming out of LDK Solar (NYS: LDK) and ReneSola (NYS: SOL) .

I don't have this position open yet, but it's on my radar as the solar shakeout continues.

What long/short pairs do you think look attractive in emerging industries? Leave your thoughts in our comments section below.

At the time this article was published Fool contributorTravis Hoiumowns shares of First Solar and SunPower. You can follow Travis on Twitter at@FlushDrawFool, check out hispersonal stock holdingsor follow his CAPS picks atTMFFlushDraw.The Motley Fool owns shares of First Solar.Motley Fool newsletter serviceshave recommended buying shares of First Solar. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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