A reverse or inverse exchange-traded fund (ETF) accrues gains not when stocks go up, but when they go down in price. The gains are directly proportional to the market’s downward movement as well. If an ETF is following an index that goes down by 2.8%, the inverse ETF rises by 2.8%. This is achieved by ‘shorting’ the stocks on the index.
Why would inverse exchange-traded funds feature among trading strategies at this point in time? It is a bear market, after all. The stock has been bullish for a number of years, but any good investor knows that in terms of trading tips, number one is that no matter how good market fundamentals may be, when it comes to stock prices, what goes up must come down.
There will be analysts who know their trends, see cup handles, and know it’s time to sell. Even if there isn’t a permanent downward pull, a temporary bear market is due sooner rather than later – the history of the stock market certainly ‘bears’ this out. There are, of course, many other factors, a looming US-China trade war that seems more likely by the week, among them. And then there’s self-correction, when everyone thinks stocks are on their way up, the value becomes inflated and the bubble can only get so big before it bursts. The bottom line is: if you want to play a market correction to your advantage, you’ll need to short stocks. One of the best ways to do this is with reverse equity exchange-traded funds (ETFs), or inverse ETFs.
Here are four ETFs that can make you money when stocks fall.
This is the most aggressive pick, and strives to attain three times the inverse of the S&P 500’s performance. As such, it carries more risk than the rest. This means if the market goes against you, you’ll bleed losses, so you have to watch this stock daily and intra-daily as well exit your position if there’s even a hint of market upswing. The plus point here is that it is the most liquid pick of the bunch – there are more than 11 million shares exchanging hands daily. The average volume is 10,878,442, net assets are at $465.94m, the yield is at 0.38%, YTD return equals -9.97% and the net expense ratio is 0.90%.
Use this ETF derivative-based fund if you expect small-cap stocks on the Russell index to fall in price as it is pegged to the Russell 2000. It’s one exemplification of how it is possible to invest in a way that only shorts one kind of stock, while remaining ‘long’ in alternatively indexed stocks. The average volume is 444,957, net assets are $248.61m, yield is 0.18%, YTD return is -6.84% and the net expense ratio is 0.95%.
The benchmark for SH is the S&P 500 so the goal is to match that index’s performance if it goes down through using derivatives. It is a short-term solution ideal for a temporary downward slump in the market. Large-cap stocks are the focus, as well as real estate investment funds to a lesser degree.
The average volume is 3,750,412, net assets are $1.37bn, yield is 0.19% and YTD return is -2.00%. The net expense ratio is 0.89%.
As an aggressive fund, the goal of the derivative-based, short-term play SDS is two times the inverse of the S&P 500, so it is a fairly high-risk fund. Use it if you strongly believe the market will drop. The average volume is 5,350,649, net assets are $848.1m, yield is 0.30%, YTD return is -5.49% and net expense ratio is 0.89%.
To sum up
It is more than likely that a short-term pullback is on the horizon. In which case, use broad index ETFs. Should you have these ETFs and bear market conditions set in, you’ll be in pole position.