3 ETFs To Short The Dow

What is an inverse ETF?

An inverse ETF is set up so that its price rises (or falls) when the price of its target asset falls (or rises). So the ETF performs inversely to the asset it’s tracking. For example, an inverse ETF may be based on the S&P 500 index. The ETF is designed to rise as the index falls in value.

Inverse or short ETFs are created using financial derivatives such as options or futures. They can even be created to move at two or three times the movement of the target asset. Because of how they’re created, though, the value of these ETFs tends to decay over time.

Inverse or leveraged ETFs typically try to track the daily performance of their target asset. So holding this kind of asset over a long period of time could compound losses. And the higher the leverage of an inverse ETF, the greater the potential decay of value due to their structure.

The ability to trade during market hours makes ETFs an ideal vehicle for financial innovation such as this. That’s one of the key advantages ETFs have over mutual funds.

Inverse / Short Emerging Markets ETFs (1x, 2x, 3x)

ETF NAME TICKER LEVERAGE BENCHMARK INDEX
Short MSCI Emerging Markets EUM 1x MSCI Emerging Markets Index
UltraShort MSCI Emerging Markets EEV 2x MSCI Emerging Markets Index
Direxion Emerging Markets Bear 3x EDZ 3x MSCI Emerging Markets Index

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Pros and Cons of UltraPro Short Dow30

Pros
  • Less risk than shorting

  • Simplifies the process of taking complex positions

Cons Requires a keen sense of market timing Any unfavorable movement has a multiplied effect on your portfolio

Pros Explained

  • Less risk than shorting: Shorting involves selling a security you don't own and then buying it back later. This exposes you to significant risk—you'll have to buy it back later, even if the price of the security has risen significantly. With short ETFs like SDOW, you buy a product outright, so your losses are limited to what you spent on the ETF.
  • Simplifies the process of taking complex positions: Aside from the risks involved, shorting is also a complex position. You'll need a brokerage that's willing to offer you leverage, and not everyone has an easy time accessing this type of account. Anyone—with any brokerage account—can buy SDOW shares.

Cons Explained

  • Requires a keen sense of market timing: Historically, stocks have risen over time. There are periods of declines, and SDOW can help you profit off these declines. However, the SDOW investor needs to have fairly precise and accurate estimates about when the markets will decline, or else they will lose money. That's much easier said than done.
  • Any unfavorable movement has a multiplied effect on the portfolio: Since it is leveraged, SDOW will multiply any movement in the Dow. That means, if you inaccurately guess the movement of the Dow, you could end up with significant losses in your account.

How to use short ETFs

Unless you’re a trader, inverse ETFs are sort of preemptive bandages. They’re a useful tool for short-term hedging. If your portfolio is overexposed to volatility, short funds allow you to dampen the impact of short-term market shocks. They’re not really designed for long-term holdings.

Most investors shouldn’t attempt to time markets anyway. History shows us that it’s nearly impossible to pick out the tops and bottoms of stock market cycles with any sort of consistency. You can sabotage long-term performance by selling your stocks out of panic and fear — going heavily into inverse ETFs would only exacerbate those problems.

Great investors accept volatility as a natural part of the stock market. They prepare ahead of time to balance volatility and growth based on their investment goals and cash needs. If you are thinking about inverse ETFs, make sure they aren’t a central part of your strategy. Think of them more as a safety valve to hold for a few days or weeks at most.

Know what’s in your ETF and how the ETF is calculated

One of the Fast Money guys mentioned the UltraShort Oil & Gas ProShares ETF (DUG) on a recent show. He questioned how that ETF, which is the double inverse of oil & gas could be up for the day while oil was also up. A quick look at what DUG actually is gives the answer:

UltraShort Oil & Gas ProShares seeks daily investment results, before fees and expenses, that correspond to twice (200%) the inverse (opposite) of the daily performance of the Dow Jones U.S. Oil & Gas IndexSM

That “daily” part adds one complication to the picture. From the article ‘Understanding ProShares’ Long-Term Performance’ on ProShares’ site:

ProShares are designed to provide either 200%, -200% or -100% of index performance on a daily basis (before fees and expenses). A common misconception is that ProShares should also provide 200%, -200% or -100% of index performance over longer periods, such as a week, month or year. However, ProShares’ returns may be greater than or less than what you’d expect over longer periods.

The article goes on to explain how & why this happens. But the question about how DUG could be up while the price of oil was also up is answered by looking at what comprises DUG — the Dow Jones U.S. Oil & Gas Index. That index “measures the performance of the energy sector of the U.S. equity market. Component companies include oil drilling equipment and services, coal, oil companies-major, oil companies-secondary, pipelines, liquid, solid or gaseous fossil fuel producers and service companies.”

Note that the actual price of oil is not mentioned. When you look at how that index is constructed you’ll see that ExxonMobil Corp. (XOM) makes up 28%, Chevron Corp. is 11% and ConocoPhillips is 7%. So at least 46% of the index is big oil companies (major integrated oil & gas). Then the question is how does the price of oil relate to movements in those oil companies? Or more broadly, how do ETFs compare against the underlying over longer periods of time?

Below I’ve plotted oil ($WTIC) vs. the ETF tracking oil (USO) over the last 10 years.

This shows that the price of oil has seriously out

This shows that the price of oil has seriously outperformed the ETF, USO. Bottom line, be careful with which ETFs you are holding long. For more on this topic, ETFDB has a good post, 7 Risks of Trading Leveraged ETFs and How to Avoid Them.

What is short selling?

Short selling is an investment strategy used by traders to speculate on the price decline of an asset. In short selling, traders borrow an asset so they can sell it to other market participants. The objective is to buy back the asset at a lower price, return it to the original lender, and pocket the difference. However, if the asset price increases, traders are on the hook to buy it back at a higher price.

Short selling is a risky strategy because the price of an asset can essentially rise indefinitely. For example, if you buy a company’s stock for $10 and the company declares bankruptcy, your potential loss is $10. However, if you short the same stock, and the company gets acquired, causing the shares to jump to $300, your potential loss is exponentially bigger as you are obligated to buy back the stock and return it to the lender.

The concept of short selling gained notoriety in 2021 when shares of GameStop jumped from around $40 to nearly $400 in a few days as short sellers were forced out of their positions.

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ProShares Short Russell2000 (RWM)

  • Bear market return: 55.4%
  • Performance over 1-Year: -30.95%
  • Expense Ratio: 0.95%
  • Annual Dividend Yield: 1.20%
  • Average Trading Volume: 2,085,612
  • Assets Under Management: $254.83 million
  • Inception Date: January 23, 2007
  • Issuer: ProShares

RWM seeks to provide a daily return, before fees and expenses, that is -1x the daily performance of the Russell 2000 Index, an index which tracks the performance of the small-cap segment of the U.S. equity market. The ETF makes use of both ETF and index swaps to achieve its inverse exposure. Since the -1x exposure is for a single day, investors holding the fund for longer than a day will be exposed to compounding effects, causing returns to deviate from the expected inverse exposure.

Direxion Daily Technology Bear 3X Shares (TECS)

Clearly, the first two bearish ETFs highlighted here are dedicated Dow plays. Obviously, the Direxion Daily Technology Bear 3X Shares TECS is an inverse technology play and not focused on the Dow Jones Industrial Average.

However, there are relevant tie ins. With Boeing's slide, the industrial sector is losing prominence in the Dow while tech is now the benchmark's biggest sector weight at 24.44%.

TECS looks to deliver triple the daily inverse returns of the Technology Select Sector Index, a benchmark that devotes almost 40% of its weight to Appleand Microsoft MSFT. That index is also home to four more Dow components: Visa V, Intel INTC, Cisco CSCO and IBM IBM.

So yes, TECS is a fine way for active traders to put on short-term, bearish Dow positions.

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