The market certainly has it up days and its down days. It seems just about anything slightly negative in the morning stock market news can send the market down a couple of percents. With inverse ETFs, you can profit on these days when the market is down hard for some reason, or a stock market correction is occurring. So even if all looks bad in the stock market some days, you can make money with inverse ETFs.
Whether it is a short term stock market correction or a long
term bear market, you can profit using inverse ETFs to short one of the major
stock market indexes.
Definition of a Bear Market
A bear market is usually defined as a 20% or more price drop
in the stock market indexes over a period of at least two months or more.
Definition of a Stock Market Correction
There is no agreed upon definition, but the most used
definition of a stock market correction is a drop of 10% - 20% from the recent
highs for the stock market or a given index during a bull market or rising
stock market. Others define a stock market correction as a decline after a
broad rising market. Today, the stock market moves so fast we can have declines
of 5% or more in a day. You can profit from bear market and stock market
corrections using inverse ETFs.
Understanding Leveraged Inverse ETFs
An inverse ETF (exchange traded fund) is an ETF that goes up
when the underlying index goes down. It is easier and less risky than actually
shorting the stock market. In other words, you can short the market without
actually having to short the market, which usually requires a person to have a
margin account at their brokerage firm.
There are inverse ETFs and leveraged inverse ETFs that
usually have the words UltraShort, 2x and 3x in their name. Leveraged inverse
ETFs are more risky and you can lose money quickly. The 2x leveraged inverse
ETF is 200% the opposite of the underlying index and the 3x is 300% the
inverse.
For example, with a 2x leveraged inverse ETF, the underlying
index goes down 5%, this inverse ETF should gain 10% and with a 3x leveraged
inverse ETF the gain is approximately 15%.
The opposite is also true if the market gained 5%, losing
you 10% with the 2x leveraged inverse ETF or approximately 15% with the 3x
leveraged inverse ETF.
The reason the leveraged ETFs are more risky is you can lose
money quickly. Yes you can profit nicely when the market is going your way, but
a quick turnaround can cause you to lose your money two or three times quicker.
So you have to pay attention.
The Risks of Inverse and Leveraged ETFs
There is more to inverse ETFs and it is recommended you only
hold these leveraged inverse ETFs for a day. The reason inverse and leveraged
ETFs can be dangerous if held longer than one day is what is called the
volatility drag or compounding error. Please read the following article The Compounding Error of ETFs and Leveraged ETFs for a further description of
this.
How to Profit in a Bear Market or Stock Market Correction
Once you feel comfortable in your knowledge about inverse
and leveraged ETFs you can go about finding the best ones for a bear market or stock
market correction. As fast as the stock market moves today, you can have a
stock market correction in the morning and be out of it by noon. So you have to pay close attention when trying to
make a profit during a stock market correction and bear markets have their sucker
rallies. You also have to be correct in the underlying index. When using leveraged
inverse ETFs, you need to be nimble enough to get out of your position quickly.
Will the DJIA (Dow Jones Industrial Average) drop
substantially in a day but the NASDAQ finish in the green. This happens quite a
bit. Will the Russell 2000 have a big drop for the day while the DOW finishes
slightly higher? You have to pick the proper inverse ETF with the proper
underlying index to profit in a bear stock market or stock market correction.
Inverse and Leveraged ETFs for a Bear Market or Stock Market Correction
This list of leveraged and inverse ETFs is for shorting the
major stock market indexes and can help you profit during a stock market
correction or a bear market. When deciding on the right ETF, it is best to
choose one with good volume or liquidity.
- ProShares Short DOW 30 (DOG), shorts the DJIA
- UltraShort DOW 30 (DXD) 2x leverage shorts the DJIA
- ProShares UltraPro Short DOW 30 (SDOW) is 3x leveraged, shorting the DOW 30
- ProShares Short S&P 500 (SH) shorts the S&P500
- ProShares UltraShort S&P 500 (SDS) is a 2x leveraged ETF to short the S&P500 index
- ProShares UltraShort S&P 500 (SPXU) is a 3x leveraged ETF for the S&P 500
- Rydex Inverse 2x S&P 500 (RSW) 2x leveraged shorting the S&P 500
- ProShares Short QQQ (PSQ) shorts the NASDAQ 100 index
- ProShares UltraShort QQQ (QID) is 2x leveraged to short the NASDAQ 100 index
- ProShares UltraShort Trust Short QQQ (SQQQ) 3x (300% inverse) of the NASDAQ 100 index.
- Direxion Daily Large Cap Bear 3x (BGZ) is a 3x leveraged ETF shorting the Russell 1000 index
- ProShares Short Russell 2000 (RWM) Shorts the Russell 2000 index
- ProShares UltraShort Russell 2000 (TWM) is a 2x leveraged ETF to short the Russell 2000 index
- ProShares UltraPro Short Russell 2000 (SRTY) is 3x leveraged for shorting the Russell 2000.
- Direxion Daily Small Cap Bear 3x (TZA) is a 3x leveraged ETF that shorts the Russell 2000 index.
- ProShares Short MidCap 400 (MYY) shorts the S&P MidCap 400 index
- ProShares UltraShort Small Cap 600 (SDD) is 2x leveraged that shorts the S&P Small Cap 600 Index.
- ProShares UltraShort MidCap 400 (MZZ) is 2x leveraged shorting the S&P MidCap 400 index.
- Direxion Daily Total Market Bear Market 1x (TOTS) shorts MSCI Broad Market Index. This index represents the total market of the US stocks on the NYSE, American Stock Exchange and NASDAQ. This ETF has rather low volume.
Conclusion
You don’t have to lose a lot of money during a bear market
or stock market correction. With inverse ETFs at the right time, you can profit
during these dismal stock market periods. Remember, the leveraged inverse ETFs
are best used for one day trades; they are not meant to be put in a portfolio
and forgotten about.
Copyright © August 2011
Sam Montana
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