How To Invest In A Stock Market Correction With ETFs

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August 29, 2013 4:51pm NYSE:DOG NYSE:SDS

etfs etfsGreg Madison: There are events unfolding right now that show you need to know how to invest in a market correction…

First, this bull market – the most unloved bull market in history, according to Money Morning Chief Investment Strategist Keith Fitz-Gerald – has continued for 54 months now. That’s a full 11 months longer than the average bull market run since 1953.

Second, the forces keeping this bull market going are almost completely divorced from any economic reality.

Unemployment and underemployment – the sheer number of Americans who’ve flat out given up looking for work – remains appallingly high, at 14%. Economic growth, limping in at under 2% per year, is anemic.

Yet, the markets have surged for more than four and a half years… hitting as high as 15,628… shattering all records as they go.

Now market crash indicators like the Hindenburg Omen – the only “crash talk” worth trading, as Fitz-Gerald told us last week – are alerting investors to prepare now. And the rising yield on 10-year Treasuries could trigger a selloff.

But a market correction, crash, or downturn is nothing to fear if you know how to invest for that scenario. A good investor is prepared to stay in – and make money in – any market.

In fact, the only sure way not to make money is to be out of the market.

So, here’s where to start.

How to Invest When Markets Fall

Inverse exchange-traded funds (ETFs) can be a powerful hedge against a downturn or crash. Even more than a hedge, they can be a tool to make money while everyone else is losing theirs.

Bearish investors nowadays have a truly staggering array of short plays to make using ETFs. If you can think of it, there’s an inverse ETF to short it: commodities, market cap ranges, precious metals, indexes, entire sectors, whole national economies, currencies – nearly anything.

Inverse ETFs can be a bit more expensive than “traditional” ETFs, but they allow investors easy access to the short game, without the hassle and expense of maintaining a margin account.

If you’re expecting any of the major indexes to go through a correction, you would naturally target an inverse ETF. You can always use an ETF that returns a one-to-one inverse of the dailyreturn of whatever you fancy:

  • ProShares Short QQQ (ETF) (NYSE Arca: PSQ) will return the daily inverse of the Nasdaq.
  • ProShares Short Dow30 (ETF) (NYSE Arca: DOG) returns the daily inverse of the Dow Jones Industrial Average.
  • ProShares Short S&P500 (ETF) (NYSE Arca: SH) returns the daily inverse of the S&P 500.

For more aggressive investors, or those with a higher risk tolerance, the UltraShort and UltraPro class of ETFs can provide multiples of the inverse of the Dow Jones Industrial Average, the Nasdaq, the S&P 500, and even the Russell 2000. (Word of warning – those considering leveraged ETFs would do well to remember that multiplied gains can turn quickly into multiplied losses.)

The ProShares UltraShort S&P500 (ETF) (NYSE Arca: SDS) is perhaps the largest inverse ETF in existence, with $2 billion in assets. It’s also the best-selling inverse product of 2013, with $1.1 billion in inflows this year. SDS is geared to provide 200% of the inverse daily return of the S&P 500 (before fees and expenses).

You’ll be in good company among the other bears in the woods. ProFund Group’s alternative ETF unit, ProShares, is one of the country’s largest alternative ETF managers.

ProShares has reported inflows of around $3.8 billion into inverse products, so far, in 2013.

A Whole Wide World of Shorts

Far from just indexes, investors can take short bets on a variety of currencies with inverse currency ETFs. Although costs for these tend to be higher than index ETFs, the rewards can be just as nice, and there’s nigh unlimited opportunity for speculation.

Technology, basic materials, consumer goods, real estate, even semiconductors are available for one-stop short selling. Wherever your bearish sentiment may lead, ProShares offers an ETF to short – with varying liquidity, assets under management, and costs, of course.

For instance, if you believe that the euro will decline relative to the dollar, you want to take a position in ProShares UltraShort Euro (ETF) (NYSE Arca: EUO). This will return twice the inverse of the daily decline of the euro to the dollar.

Or if you have a notion that oil might tank, but don’t know the best way to parlay those depressed prices into gains, you can buy ProShares UltraShort DJ-UBS Crude Oil ETF(NYSE Arca: SCO). This is one of the most popular inverse oil ETFs around, albeit with higher costs than most inverse index ETFs. It gives twice the inverse daily performance of West Texas Intermediate (WTI) crude.

If you feel a correction or a crash is in the offing, you could play that for profit by shorting the entire financial sector. The ProShares UltraShort Financials (ETF) (NYSE Arca: SKF) will return twice the inverse of the daily Dow Jones financials sector.

Warning to the Down-Market Profit Hunter

Before you get into trading inverse ETFs to invest in a market correction, there are some important things to consider…

It’s very important to note the use of the word daily in relation to the inverse index ETFs. That’s a crucial caveat.

It means these are by no means buy-and-hold investments, and treating them that way is dangerous. It’s not wise to let these simply “ride out” a market downturn or crash, because your holdings of inverse ETFs can take a hit on a rally, no matter how brief.

As we’ve reported before, one must always remain vigilant and attuned to their portfolio performance to succeed, and this rule of thumb definitely applies to inverse ETF speculation.

These are better thought of as trading vehicles or tactical tools. You’ll need to make continual adjustments to your position should a trend emerge.

That being said, if you want more on how to invest in a market correction, ETFs are just one way that you can have your fill of short plays – and make a killing while all others are being killed.

More Than One Path to Post-Crash Riches

There’s also the Chicago Board of Options Exchange Volatility Index (VIX). Some call it the Fear Index, and it’s held to be the best gauge of volatility around. In fact, it may be one of the best contrarian indicators in the world.

When volatility takes hold and drives down the price of options on the S&P 500, the Fear Index almost always enjoys a healthy bump. During the recent broad market downturn, the VIX saw some powerful, historic upward surges. For instance, August 21, 2013, saw the VIX jump by 6.91%. And for nearly all of this August, money has been pouring into call options on the VIX to the point where open interest has peaked to its third-highest volume in history.

There’s a way to play the Fear Index, a vehicle designed especially for speculator pros who feel bearish about the S&P 500. But with this, you’ll be a pro in no time flat, and well on your way to trading on this killer index. Here’s how you do it.

Money MorningWritten By Greg Madison From Money Morning

We’re in the midst of the greatest investing boom in almost 60 years. And rest assured – this boom is not about to end anytime soon. You see, the flattening of the world continues to spawn new markets worth trillions of dollars; new customers that measure in the billions; an insatiable global demand for basic resources that’s growing exponentially; and a technological revolution even in the most distant markets on the planet.And Money Morning is here to help investors profit handsomely on this seismic shift in the global economy. In fact, we believe this is where the only real fortunes will be made in the months and years to come.

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