Ultra-Short ETFs

Robert Hsu, February 06, 2008

Professional traders are using hedging strategies more and more -- especially when volatility increases during panic sell-offs like the one we saw on Tuesday. This week, I will show you how you can hedge your portfolio by shorting the U.S. market.

Traders sell stocks short when they believe the market will go lower. Instead of buying low and selling high, the short-seller does the reverse: sells high, and then, after the market has fallen, covers the position by buying at low prices.

For those of you who may not be familiar, when traders short stocks, they don't actually own the shares. Instead, they borrow shares from a broker and sell them to a third party. Essentially, the trader is selling a stock that he doesn't own at a high price and is buying it back at a lower price. I should point out that there is a lot of risk to hold a short position. When you buy stocks, your maximum loss is the amount of your investment. But when you short stocks, your potential loss is endless.

Shorting positions is risky because of the limitless downside. There is a much easier way to make money by betting that a stock or the market is headed lower:

Exchange traded funds (ETFs) are baskets of securities that trade like individual stocks, so they can be sold short. Although regular ETFs can be shorted, it's often very difficult for individual investors to borrow the shares. Therefore, exchange-traded fund manager ProShares launched several leveraged and inverse ETFs geared to automatically short stock indexes. The leveraged and inverse ETFs use complex financial instruments such as derivatives to carry out their objective. They offer a new way for investors to short the market while taking on less risk than shorting individual stocks.

Among the many benefits to buying short ETFs is that they're easier to trade and they eliminate a lot of the risk involved in shorting. Instead of selling first and facing unlimited losses, we can buy shares of the short ETF. The short ETF will rise when the market falls. We only risk the purchase price of the investment.

Do you want to know my top ETF picks? Subscribe to Asia Edge by clicking here!

Like what you read? Join Asia Edge today.

Already a member? To view the full article, click on this link.

Sponsored Links

What's happening in the world's major foreign markets right now? Will current events affect the stocks in your portfolio? Read InvestorPlace Asia's Top Stories to find out everything you need to know in order to stay on top of global economic news.

more...

Every country has its own special customs and traditions. Being familiar with a country's culture can often make a difference in whether you gain or lose from investing in its stock market. Check out our culture section to learn more about the societies of the world's fastest-growing emerging economies.

more...

There's a lot happening around the world today, and it's important to know how it's affecting your investments. Watch the latest videos covering important Asia topics!

more...