Time flies. A lot has happened and yet not much has changed. Since the beginning of the year, we've seen three months of relentless selling, followed by a persistent five month rally. Today, the Dow Jones (DJI: ^DJI), S&P 500 (SNP: ^GSPC) and Nasdaq (Nasdaq: ^IXIC) are at levels comparable to early January 2009.

On February 2nd, I wrote an article titled: '11 ETFs for The Dow 6,500 Portfolio.' At the time, this article drew its fair share of mockery and critisism. It didn't take long, however, for the Dow (NYSEArca: DIA - News) to actually drop below 6,500. 6,440 on March 9th market the intraday bottom of this down-leg.

Subscribers to the ETF Profit Strategy Newsletter received a Trend Change Alert on March 2nd with the straight forward advice to sell short ETFs (which we recommended buying early January) and buy (leveraged) long ETFs since a 40% rally was about to start. Long ETFs included plain vanilla index ETFs like the S&P 500 SPDRs (NYSEArca: SPY - News), sector ETFs like the Financial Sector SPDRs (NYSEArca: XLF - News) or their leveraged cousins.

The similarities between January and the present month of August are strikingly familiar. The rally from November 2008 proved to be fertile soil for theories of, the (first) bailout is working and the worst is behind us. Of course, that was not the case.

The rally from the March 2009 lows, nurtured the same type of sentiment to an even larger degree. The bailout is said to be working. Reuters reported that the Blue Chip Economic Indicators survey of private economists, showed about 90% of the respondents believe the economic downturn will be declared to have ended this quarter.

This is consistent with skyrocketing sentiment readings which have recorded extremes not seen for well over a year. For realistic (I prefer realistic over contrarian) investors like myself, this is a sure sign of trouble ahead.

It is this enthusiasm for stocks - and only this enthusiasm - that has been driving prices higher, despite a mixed bag of economic news.

The one fact you must know about investing

The stock market is devious, and will do what it takes to separate as many people as possible from their hard earned dollars. The persistent rise from the March lows is converting bears into bulls and bulls into XL bulls while contrarians, realists, and bears are becoming extinct.

Investors who fear they've lost out on this rally have begun pouring their money back into the market to avoid missing out on the next big bull. At a certain point, all the money which has been waiting on the sideline will have been dumped back into the market.

At that point, and even before that point, the base of stock owners will have become bigger than the number of investors wanting to own. Once all the dollars have been poured into the market, there is little money left to buy more stocks. Based simply on the law of numbers, sellers will overcome buyers and stock prices will fall.

Falling prices, in turn, will produce more sellers, depressing prices even more. Once this downward spiral is set in motion, it will be hard to stop. It will become clear that the bailout did not, and will not, work. Better than any auditor, the continued bear market will reveal more scams, Ponzi schemes, and improprieties resulting in further downward price pressure.

Watch out! Lower prices ahead

Of course, investor sentiment is not the only foundation for a bearish outlook. Valuation measures originating from the market itself have proven to be very reliable. In fact, a look at history reveals that no prior bear market has bottomed unless P/E ratios and dividend yields (the easiest reflection of value) have clocked in at levels indicative of a bottom.

Once this rock bottom level is reached, those valuation metrics trigger the green light for a sustainable rally. Unless the valuation metrics reset, the market simply is not ready for the next bull market. Failure to reset can be illustrated by a boat wanting to leave harbor without pulling up anchor, it won't get far.

In case you are not convinced that lower prices are ahead, consider some of the following factors in favor of a major decline:

1) unemployment will continue to rise 2) home prices will continue to fall 3) banks will continue to lose money 4) the Public Private Investment Program is littered with flaws 5) many banks still operate with a 30 - 50% leverage (this means a 2% decline in assets could wipe out an entire bank) 6) Japan's Nikkei fell from 40,000 to below 8,000 7) the Great Depression  reduced the Dow Jones by 89.2% (there was also a 48% counter trend rally after the initial decline) 8) company earnings were often artificially inflated and not sustainable. Other earnings estimates were low-ball benchmarks impossible not to beat 9) commercial real estate is at the brink of a meltdown 10) prime, fixed mortgage loans now account for most defaults 11) U. S. home foreclosures are likely to total 6.4 million by mid 2011, up from the current 1.8 million (a 255% increase), etc.

The Dow 5,000 portfolio

First and foremost, if you can't afford to lose money then leave it in safe cash, or a safe cash alternative.

Once the next wave of selling hits, short ETFs (in particular leveraged short ETFs) will once again rule the list of top performing funds. Ironically, brokers like Ameriprise, Edward Jones, LPL Financial, Morgan Stanley, and UBS have either banned or temporarily halted the sale of leveraged (short) ETFs, the one asset class that will actually have positive returns.

Short ETFs aim to provide 1x, 2x, or 3x the inverse DAILY performance of the underlying index. We do realize that leveraged ETFs are not without their flaws. However, just like a power tool used correctly, leveraged ETFs will get the job done. We recommended short leveraged ETFs in January 2009 and long leveraged ETFs in March 2009. There may have been some deviation from the underlying index, but in both instances the ETFs added significantly to the bottom line and made their owners happy.

Conservative short options

Single inverse short ETFs linked to one of the major benchmarks are the most conservative approach to profit in a down market. Such ETFs include the Short S&P 500 ProShares (NYSEArca: SH - News) and Short Dow Jones ProShares (NYSEArca: DOG - News).

The financial, real estate, and small cap segment is likely to lead the charge to lower lows. Single inverse exposure can be found via the Short Financial ProShares (NYSEArca: SEF - News) and Short Russell 2000 ProShares (NYSEArca: RWM - News).

Aggressive short strategies

Double or even triple exposure to the financials, real estate, and small caps is one of the most aggressive ways to profit in a down market. Keep in mind that 2x and 3x leveraged ETFs move very fast and require a stomach for volatility. If you are willing to accept the risk for the potential huge pay off, those ETFs are for you.

The UltraShort Financial ProShares (NYSEArca: SKF - News) aim to deliver 2x the inverse daily performance of the financial sector. The Direxion Daily Financial Bear 3x Shares (NYSEArca: FAZ - News) aim to deliver 3x the daily inverse performance of the same sector.

The UltraShort Russell 2000 ProShares (NYSEArca: TWM - News) aim to deliver 2x the inverse daily performance of small cap stocks, while the Direxion Daily Small Cap Bear 3x Shares (NYSEArca: TZA - News) provide 3x exposure to the daily inverse performance of small company stocks.

How to avoid getting burned

As mentioned, leveraged short ETFs are powerful tools if used correctly. Timing is the key ingredient when it comes to investing with leveraged ETFs. The March 2nd Trend Change Alert expected leveraged long financial ETFs to become the best performing ETFs over the coming months. The 2x financial ETF (UYG) has gained 300% and more, since. Once again, the key is owning the right type of leverage (short or long) at the right time.

The most recent issue of the ETF Profit Strategy Newsletter provides a short, mid, and long-term outlook for the stock market, along with recommended ETF profit strategies and entry prices. Investors can't stop the waves (trend), but they can learn how to surf (invest properly). Short ETFs can be your surf board for the foreseeable future.