This market is just like the Energizer Bunny—it keeps going, and going, and going. But at some point, even this uber-energized equity bunny will need to stop and recharge its battery. When this happens, we’re likely to see a correction of anywhere from 7% to 10% nearly across the board. Now, there are three ways you can respond to a correction. First, you can sell your positions and head into the safety of cash. Second, you can just ride the pullback out and hope that it doesn’t turn into a bear market of the sorts we witnessed in 2008 and early 2009. Or, you can do what the smart money does and use inverse exchange-traded funds (ETFs) to collect big profits while stocks on are the retreat.
Fortunately, the current universe of ETFs is so broad that making money when stocks go down is not a matter of how, but a matter which inverse ETFs to choose from. Let’s take a look at eight great ETFs you can use to profit when the herd on Wall Street is selling.
If you want to make money when the wider market is going up, you can do so via ETFs tied to broad market indices such as the S&P 500, NASDAQ 100 and Russell 2000. Conversely, if you want to make money when the broad market is going down, you can use inverse ETFs tied to those same indices.
For example, if you think the S&P 500 is about to do an about face, you can buy the ProShares Short S&P 500 (SH). This ETF is designed to move inversely with the S&P 500. So, of the S&P 500 falls 2%, SH will rise 2%. More risk-tolerant investors can double their bets on the decline in the S&P 500 if they buy the ProShares UltraShort S&P 500 (SDS). This fund is designed to deliver twice the inverse performance of the S&P 500, which means if the S&P 500 falls 2%, SDS will rise 4%.
This ability to in effect short the S&P 500 either with a one-to-one ratio or with leverage that doubles your profit potential can also be had in two other high-flying major market indices—the NASDAQ 100 and the Russell 2000. If you want to go against the grain in the NASDAQ 100, you can use the ProShares Short QQQ Fund (PSQ). If you want to double your bet on the downward direction of the Qs, you can use the leveraged version, the ProShares UltraShort QQQ (QID). You can go against the Russell 2000 with the ProShares Short Russell 2000 (RWM), and if you want to add the leveraged play to your mix, you can use the ProShares UltraShort Russell 2000 (TWM).
Of course, broad market indices aren’t the only ways to play a widespread equity correction. You also can use inverse sector ETFs to capitalize on the downdraft in specific market segments. When the next correction takes place, the most vulnerable sectors of the market will likely be the ones that have run up the highest in recent months. Two of those sectors are real estate and financials.
One way to play a pullback in real estate is with the ProShares UltraShort Real Estate (SRS). This leveraged ETF seeks price performance that equals twice the inverse of the real estate investment trust (REIT)-heavy Dow Jones Real Estate Index. So, if this REIT index falls 2%, SRS is designed to rise 4%. If you want to take advantage of a potential decline in financial stocks, you can use the ProShares UltraShort Financial (SKF). This fund is designed to deliver price performance equal to twice the inverse of the Dow Jones U.S. Financials index, an index containing the biggest names in the banking sector.
Finally, remember that using inverse ETFs — and especially the leveraged variety — come with a healthy dose of risk. You should therefore be very cautious when adding these funds to your portfolio, and that cautious approach should include the use of stop-loss orders along with your short ETF buy orders.
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