Daily Stock Pick: August 24th, 2022

Stocks notched slightly higher this morning, taking back some of the losses of the past three sessions as markets awaited central bank guidance during the Federal Reserve’s annual three-day economic policy symposium, slated to begin on Thursday. Fed Chairman Jerome Powell is among the featured speakers expected to discuss the most pressing obstacles the economy faces and the central bank’s plan for tightening policy. 

Many of the pros on Wall Street predict a bumpy road for stocks, with the Fed expected to remain aggressive on its policy tightening path, presenting an especially attractive opportunity for active investors. “Financial markets will remain in choppy waters until Fed Chair Powell’s Jackson Hole speech on Friday, said Ed Moya, senior market analyst at Oanda. “He may struggle to convince markets that he is comfortable with tightening policy and triggering recession. The economy is clearly slowing, but it’s still too early for the Fed to signal that they will be less aggressive with tightening policy,” he continued.  

Today we’ll discuss a short-term play that allows traders to benefit from backslides in the market. This valuable tactic can be used as a hedge and to generate quick profit when things take a turn. 

Empire Research:

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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 risk 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, you can expect that the inverse ETF will perform “the opposite” of the index over short periods, but a disconnect may develop over more extended periods. 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 increases 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, this is the fund that moves in the opposite direction of the largest 500 U.S. corporations and 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 monthly. 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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