Inverse exchange-traded funds (ETFs) are commonly used in advanced trading strategies. However, they can also assist any investor in opening a bearish stance or hedging their downside risk in a commodity or industry. Because of their complexity, you should learn everything you can about these funds, also known as "short ETFs," before adding any to your existing portfolio.
What Is an Inverse Exchange-Traded Fund (ETF)?
Inverse exchange-traded funds (ETFs) are index ETFs that gain value when their corresponding index loses value. It accomplishes this by holding assets and derivatives, such as options, that are used to generate profits when the underlying index declines. When the Dow Jones Industrial Average falls, the Short DOW 30 ETF (DOG) makes money. The profits of the DOG are equal to the losses of the Dow. Warning: Although inverse ETFs are risky investments that should be approached with caution, there are a few ways that investors can benefit from them. Investors who have a high level of risky exposure to a specific index, sector, or region can use an inverse ETF to help hedge their risk. They can use inverse ETFs as part of their investment strategy to gain market downside exposure. If your research has led you to a bearish stance on an index or sector, investing in an inverse ETF could be a less risky way to make that bearish bet.The Benefits of Inverse ETFs
Inverse ETFs offer many of the same benefits as a standard ETF, such as simplicity of use, lower costs, and tax benefits. The advantages of inverse ETFs come from the additional options for placing bearish bets. Short selling assets is not possible for everyone who does not have access to a trading or brokerage account. Instead, these investors can buy shares in an inverse ETF, which provides them with the same investment position as shorting an ETF or index. Inverse ETFs are riskier than traditional ETFs because they are purchased outright. As a result, they are less risky than other bearish bets. When an investor shorts an asset, the risk is often limitless. The investor might lose a lot more money than they expected. When investing in inverse ETFs, keep in mind that you can only lose as much as you paid for the ETF. In the worst-case scenario, the inverse ETF will become worthless, but you won't owe anyone any money, unlike when you short an asset traditionally.Inverse ETFs have disadvantages
The lack of popularity of inverse ETFs is one of the biggest risks they face. Many types of ETFs are available for purchase, but inverse ETFs are not among them. As a result of fewer options and lower demand, inverse ETFs are likely to have lower liquidity than other ETFs. Another danger is that when the timeframe is long enough, major stock indexes have historically risen—because of this, using inverse ETFs in a buy-and-hold strategy can be risky. According to history, the index's recent losses are likely to be recouped sooner rather than later. Inverse ETF investors must closely monitor markets. They can try to get out of their position before the indexes rally.Consider These Funds
If you want to hedge some portfolio risk or have a bearish feeling about a specific market index, consider the following inverse index ETFs: Short S&P 500 (SH) tracks the S&P 500 Index in the opposite direction. The Russell 2000 Index is inversely tracked by the Short Russell 2000 (RWM). If a certain market sector worries you or you have a bad feeling about a certain industry, keep an eye on the following inverse ETFs: The Dow Jones U.S. Financial Index is inversely tracked by UltraShort Financials (SKF). The Dow Jones U.S. Industrials Index is inversely tracked by UltraShort Industrials (SIJ). The Dow Jones U.S. Real Estate Index is inversely tracked by UltraShort Real Estate (SRS). Inverse ETFs for specific country and region indexes are also available. The MSCI Japan Index is inversely tracked by UltraShort MSCI Japan (EWV). The UltraShort FTSE China 50 (FXP) index tracks the FTSE China 50 Index in the opposite direction.Final Thoughts
Inverse ETFs can be useful in your investment strategy, but you should always do your homework before making any trades. Consider both the advantages and disadvantages. Before you begin, keep an eye on the performance of some inverse ETFs. Talk to a financial professional or broker if you have any questions or concerns. In the world of ETF investing, your research and due diligence are essential tools.Most commonly asked questions (FAQs)
What is the difference between an inverse leveraged ETF and a traditional leveraged ETF?
The investment objectives of a short ETF are combined with the increased volatility of a leveraged ETF is an inverse leveraged ETF. The UltraPro Short Dow30, for example, seeks to provide three times the Dow Jones Industrial Average's inverse exposure. This inverse leveraged ETF would rise by about 3% if the Dow dropped by about 1%.How long should an inverse ETF be held?
Although inverse ETFs have a wide range of investment strategies, the majority of these products are used for relatively short-term investments. Despite being profitable in shorter time frames, a long-term inverse index method has traditionally been a failed proposition because the stock market has a tendency to rise over time. We don't offer financial, tax, or investment services or advice. The information may not be appropriate for all investors as it is being provided without taking into account the investment objectives, risk tolerance, or financial situation of any particular investor. Past performance does not guarantee future outcomes. Investing entails risk, including the possibility of losing money.