Inverse ETFs: Profiting from Down Markets - A Comprehensive Guide

The inverse ETF is an investment tool that allows you to profit from a declining market. With the inverse ETF, you actually want the price of certain assets to decrease. If the asset prices decrease, you actually make money from the investment. While this may sound like it goes against the basic rules of investing, it can be a sound investment strategy under the right circumstances. Here are a few things to consider about inverse ETFs and how they work.

How They Work

An inverse ETFs is designed to be an investment tool for those that want to bet on the market declining. In order to do this, the ETF fund managers are not actually buying up assets like they do for a regular ETF. Instead they engage in derivatives, short selling of stocks, and swaps with other investment houses. Each inverse ETF works a little bit differently, but it is set up to track the inverse of a particular index. For example, you can get an inverse ETF that is associated with the Dow Jones. If the Dow Jones industrial average goes down, the inverse ETF goes up in value by the same amount. 

Depending on the way the inverse ETF is set up, you can actually get two times the movement in the opposite direction. If the index goes down by 1 percent, you would actually gain 2 percent in your account. Therefore, an inverse ETF can potentially bring you a nice return if you time it correctly. 

Benefits of Inverse ETFs

• Profit in spite of the market--Many investors tend to lose faith in the system when the market takes a downturn. Instead of being one of that kind of investor, you might as well find some methods that can still allow you to profit when everything else is down. The inverse ETF allows you to do just that. 
• Hedge--Many investors try to take measures to hedge their accounts. With the inverse ETF, you can protect your regular investments in case the market goes down. This can create some more certainty in your portfolio even if things do not go according to plan in the market. 
• Does not require margin--If you were to try to short sell stocks on your own, you would have to set up a margin account with your broker. However, with this type of arrangement, you can just buy and sell the shares with a regular brokerage account. Trading with margin is going to increase your risk as well. This way, you can keep your risk to a minimum and still take advantage of a short sale scenario.

Risks of Inverse ETFs

• Only works in short term--When you are investing in the decline of the market, you can only use this as a short-term solution. Historically, the market tends to go up over the long term. Therefore, if you bet that the market will decline, eventually you will lose.
• Requires timing--Since the market always goes up eventually, you will have to time it just right to profit from an inverse ETF. You have to buy at the top and sell at the bottom of the market.