Stocks were markedly lower in early trading this morning as a number of factors weighed heavy on investor sentiment. Concerns about rising rates, inflation, and uncertainty on the debt ceiling added to the pressure.
October has been a roller coaster so far. During the past three sessions, the S&P 500 has taken and given back the same 60 points, and this morning was looking to return yesterday’s gains and revisit the 4,300 level. The five-day chart looks more like an EKG reading than anything. This is the type of volatility that can create stellar opportunities for active traders.
Today, we will discuss an essential tactic that allows investors to benefit when things get ugly by taking a position opposite a losing market. It’s not risky short-selling. In fact, many of the Wall Street pros consider this tactic a more logical alternative to short-selling. It’s an important tool to have in your tool kit in times of heightened volatility. Read on to learn how to put this valuable tactic into play.
Empire Financial’s Joel Littman
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Traders who are looking to benefit from sliding stocks often turn to short-selling. The main risk of traditional short-selling is that while profit is capped (a stock can only fall to zero), the risk is theoretically unlimited. Of course, other tactics can be used to cover a position at any time, but with a short-selling position, inventors are at risk of receiving margin calls on their trading account if their short position moves against them.
Inverse or “short” ETFs are another option that allows you to profit when a particular investment class declines in value. Some investors use inverse ETFs to profit from market declines, while others use them to hedge their portfolios against falling prices.
Over short periods of time, you can expect that the inverse ETF will perform “the opposite” of the index, but over longer periods of time, a disconnect may develop. Inverse ETFs will decline as an asset appreciates over time. For that reason, inverse ETFs typically are not seen as good long-term investments. Furthermore, frequent trading often leads to an increase in fund expenses, and some inverse ETFs have expense ratios of 1% or more.
When approached correctly, inverse ETFs can be excellent day-trading candidates and highly effective short-term hedging tools. There are several inverse ETFs that can be used to profit from declines in broad market indexes, such as the Russell 2000 or the Nasdaq 100. Also, there are inverse ETFs that focus on specific sectors, such as financials, energy, or consumer staples.
With $4 billion in assets, the ProShares Short S&P 500 (SH) is the largest inverse fund by value. Commonly used by investors as a hedging vehicle, the fund strives to deliver the inverse performance of the S&P 500 (SPX). If you’re concerned about the stock market falling, then this fund that moves in the opposite direction of the largest 500 U.S. corporations is the simplest way to protect yourself. It’s important to note that SH is designed to deliver inverse results over a single trading session, with exposure resetting on a monthly basis. Investors considering this ETF should understand how that nuance impacts the risk/return profile and realize the potential for “return erosion” in volatile markets. SH should definitely not be found in a long-term, buy-and-hold portfolio. The fund comes along with an expense ratio of 0.9%
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