by Traders Reserve | May 21, 2012 2:00 pm
After a truly impressive first-quarter for the markets, stocks have come a tumblin’ down. Although the S&P 500 Index still is in positive territory for the year, the benchmark measure of the domestic markets is down more than 8% since hitting its April 2 high. The selling has been much bigger in emerging markets—thanks in large part to European debt woes. The global weakness has even spread to commodities such as gold and oil, as both have fallen sharply in recent weeks.
Now, there are a couple of things a trader can do in the face of the recent downtrend. You can sell your long positions and hunker down in fear, or you can take advantage of the selling[1] with exchange-traded funds (ETFs)[2] designed to move higher when stocks are in descent. I prefer to do the latter, but before doing so we have to know which of these inverse, or short, ETFs give us the best chance at making money.
If you think the latest selloff in equities is a harbinger of more widespread pain to come, then your broadest bet is the ProShares Short S&P 500 (NYSE:SH[3]). This inverse ETF is designed to move in the opposite direction of the broad market S&P 500 Index.
Basically, if the S&P 500 were to go into correction mode, falling another 5% or so from where it trades right now, then SH would gain about 5%. Putting SH in your trading portfolio gives you an easy, low-cost way to hedge your long portfolio against further selling.
More intrepid traders might want to double down on their short bets against the broad market, and doing so is easy with the ProShares UltraShort S&P 500 (NYSE:SDS[4]). This fund is designed to deliver twice the inverse performance of the S&P 500 Index, so if that index were to correct by 5%, then theoretically you could get a 10% gain via SDS.
While the prospects of this kind of gain may be tempting, remember that inverse ETFs can be quite volatile. If you’re going to use them, make sure you have a stop-loss in place to protect yourself if things don’t go your way.
Even before the latest selling in stocks caught fire, emerging markets had already started burning. One of the darling sectors of the market in recent years, emerging markets stocks now are down nearly 16% since hitting their most recent high in March. Taking advantage of a continued slide in this sector is easy with the ProShares Short MSCI Emerging Markets (NYSE:EUM[5]). The fund is up nearly 12% over the past month, and that number is likely to keep climbing as we muddle through the traditionally difficult summer months for stocks.
The small-cap segment of the market is usually volatile when compared to its mid- and large-cap brethren. That’s true on both the upside, as well as the downside. Lately, the downside trend is here in small caps, and that means big profit opportunities in the Direxion Small Cap Bear 3X Shares (NYSE:TZA[6]).
This fund is designed with aggressive traders in mind, as it employs leverage toward its goal of delivering three times the inverse performance of the small-cap Russell 2000 Index. If you’re firmly bearish on small caps, then TZA is great way to put your money where your conviction is. Those who have done just that over the past month have been rewarded with gains of more than 18%, and that’s the kind of profits that can make a trader’s portfolio.
The final inverse ETF on my list may be a bit counterintuitive, especially as we move into the summer driving season, but given the recent pullback in crude oil prices it just might offer your portfolio supercharged returns.
I am referring here to the ProShares UltraShort DJ-UBS Crude Oil (NYSE:SCO[7]), a fund that is a two-beta leveraged bet against crude oil prices. Basically, if oil prices were to fall 4%, then SCO would likely surge 8%. Over the past month, we’ve seen SCO surge 23%, as oil prices have tumbled due in large part to renewed fears over a global economic slowdown.
If we see more European-induced woes, we are liable to see more selling in oil—and that means more profits with SCO.
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