Despite not tracking indexes exactly, I think there’s money to be made from exchange-traded funds that let you “go short” and amplify your returns through leverage. When the inevitable correction or crash comes, that is.
If you think that markets are going to suffer a correction or crash, you’ll want to go short, but it’s hard to do this in a traditional stockbroker account.
If you want to make big money, you’ll need to use leverage, but this also isn’t easy in some stockbroker accounts. The answer could be to buy a short or inverse leveraged ETF.
What Is a Short or Inverse Leveraged ETF?
Let’s break it down by considering the terms ETF, short/inverse, and leverage separately:
An exchange-traded fund (ETF) is like a mutual fund that pools money from many investors and invests it in many assets such as stocks; often those that track a stock index such as the S&P 500. Unlike mutual funds, ETFs can be traded at any time during the trading day in the same way that you would buy or sell single stocks.
The value of a short or inverse ETF goes up when the underlying index goes down, and vice versa.
Leverage means that your gains (and losses, so be careful) are amplified; e.g., by a factor of three.
Should You Buy an ETF to Make Money From Falling Markets?
Whenever I write about these kinds of ETFs, I always allude to the fact that they don’t track the underlying indexes exactly because of the way they use daily derivative financial instruments(under the covers to achieve the inverse leverage. Put simply, the cumulative return from the “daily resets” over several days, weeks, or months doesn’t match the net return of the index over the same period.
Does this matter? Not if you’re a purely technical trader who looks for price chart patterns irrespective of the underlying reasons. After all, a Nasdaq-100 tracker doesn’t track the S&P 500 index exactly either, but it doesn’t stop me shorting it on its own technical terms as a proxy for falling markets.
If a chart such as the following one shows plenty of potential for an inverse leveraged to go up far and fast if the market goes down, I’m tempted to take a punt with a limited initial investment.
Source: Barclays Smart Investor
Where Can You Buy Short or Inverse Leveraged ETFs?
Traditional stockbrokers that don’t normally let you go short or use leverage — e.g., UK brokers that offer stocks ISA or SIPP accounts — will nonetheless often offer short or inverse leveraged ETFs for you to buy.
Alternatively, online brokers that already let you use leverage via contracts-for-difference (CFDs) often offer ETF CFDs, and in this case, the ETFs themselves don’t have to be inverse or leveraged because the brokers let you short-trade the long ETFs using the leverage they provide.
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