How to use Etfs to Bet against the Stock Market

ETF stands for “exchange traded fund”. In essence, an ETF is a portfolio of positions held by a financial institution. When you purchase a share in an ETF, your money is invested in that portfolio. The value of the shares is determined by a weighted average of the performance of the portfolio positions. The most well-known ETF is probably QQQQ, the NASDAQ powershares ETF, which is a collection of stocks from the NASDAQ. It is an example of an ETF composed of long stock, i.e., stocks purchased by the financial institution and held in the portfolio.

If the performance of those stocks decreases, the value of QQQQ decreases. Hence, buying QQQQ (or buying a call on it) is a bullish bet on the NASDAQ. Shorting or buying a put on QQQQ would be one way to benefit from a downward move in the market. However, even if you do not feel comfortable shorting stock or trading options, there are ETFs that allow you to make bearish bets.

ProShares offers a variety of what are called “short ETFs”. By purchasing a share of such an ETF, you are having your money invested in a portfolio of short stocks managed by a professional. You don’t need to worry about the details of handling short sales. As far as you are concerned, you are “long” shares of the ETF, and you can think of it as you would any other stock. The same old rules apply- buy low, sell high. The only difference between a short ETF and a long ETF is that the short ETF will increase in value when the underlying stocks decrease in value.

For a conservative money management strategy (perhaps an IRA) having some shares of short ETFs is an excellent idea. Note that if you own (for example) both QQQQ and Short QQQ, they cannot simultaneously increase in value! One will be making money and one will be losing it. You are capping your maximum profit by taking both sides of the bet.

If the market happens to be consistently bullish or bearish, you will probably feel you made a mistake by investing in both long and short ETFs. However, by sacrificing some of your potential returns, you have also buffered your portfolio against loss. You won’t be able to “lose it all” if the NASDAQ skyrockets or plummets, since you have shares that will do well in either case. This idea is what is known as “hedging”.

Hedging strategies usually involve options and require some level of micromanagement. Short ETFs are a much simpler and more “hands off” approach to risk management. You can still take a directional stance. Buy more short shares if you are bearish and more long shares if you are bullish, but make sure you always have enough of the other to protect against a devastating loss. A hedging strategy is an insurance policy, and while you lose the “premium” it can end up being a very wise investment if the unexpected happens.