In a nutshell, an inverse ETF refers to an exchange-traded fund that allows investors to earn from a benchmark. Meanwhile, this benchmark can be in the form of another ETF, an index, or an asset. It entails the use of derivatives to earn money from the devaluation of an underlying asset.
So, what are inverse ETFs? Are they good investments? Keep on reading and learn more.
How Do Inverse ETFs Provide Portfolio Protection?
You might be asking, are inverse ETFs good? Well, to be straightforward, they can be good, but in most cases, they will be risky. This is especially the case if you’re a new investor. Therefore, experts recommend this only to those with extensive trading experience and those who have a huge risk appetite.
Despite being a risky investment, inverse trading can deliver a plethora of benefits. Among others, one of the best things about an inverse ETF strategy is that it might offer portfolio protection. Hence, it can provide peace of mind and a sort of safety net, if you do things correctly.
Let’s say your investment portfolio has assets that link to a specific index. If you invest in inverse ETFs in the same index, it means that you can still profit in case of a market downturn. However, this means that you still need to be right in your forecast to be profitable.
Exploring the Mechanics of Inverse ETFs
To further understand what are inverse ETFs, it’s also crucial that you learn how does an inverse ETF work. By being aware of its mechanics, you can take advantage of its many benefits.
If you’re wondering about how do inverse ETFs make money, one thing you should understand is their use of derivatives. These derivatives can be in the form of daily futures contract or a similar tool.
Under a futures contract, you’ll buy or sell at a specified price and time. Essentially, you’re betting in the opposite direction of the asset, which is how your investment will yield a return.
More so, another important thing to learn in the mechanics of ETFs is that it’s available in different asset classes. The most popular categories include fixed income, equity, currency, commodities, and alternatives.
A Step-by-Step Guide to Investing in Inverse ETFs
Are you clueless about how to invest in inverse ETFs? It’s actually easy! Nonetheless, while the process itself is easy, take note that the strategy can be complicated. With this, it’s a type of trading that’s best for those with experience.
Here’s a quick guide on how to buy inverse ETF to help you start on the right foot:
- Level Up Your Knowledge: The first thing to do is educate yourself. It’s not enough to learn what are inverse ETFs. Dig deeper, and as you expand your knowledge, you’ll be more familiar with the ins and outs of inverse trading.
- Pick the Right Asset: Not all assets are the same. You need to be analytical and technical as you compare your options. Choose one you believe will be affected by a market downturn. You must be bearish on the asset or industry.
- Place a Sell Order: When it’s time to exit your position, you must put up a sell order. The right timing is crucial, which brings us to the next point.
- Know How Long to Trade: Inverse ETFs are short-term trading instruments. Ideally, you should hold it only for less than a day. Otherwise, you might end up losing big, especially without diligent monitoring.
Utilizing Inverse ETFs for Effective Risk Management
Hedging is one of the most effective strategies for portfolio risk management. With this, you’re probably thinking about how to hedge with inverse ETFs.
Let’s say you have a stock portfolio, and you worry that the price will plummet. To safeguard your investment, you can hedge inverse ETFs to lessen portfolio risk. Even when you’re bullish, hedging can provide peace of mind in case the market becomes unfavorable.
While hedging inverse ETFs can be helpful in managing risk, this strategy can be the risk in itself. Losses can be apparent if you invest too much. At the same time, your portfolio can also plummet when you have the wrong timing for market entry and exit.
Effective risk mitigation requires a thorough analysis of external factors that impact the asset’s performance. You need to be proactive instead of reactive. Meaning, you must be able to anticipate the market downturn. Otherwise, it will be too late before you can make your next move.
Where to Buy and Trade Inverse ETFs for Profitable Strategies
Knowing where to buy inverse ETF is vital for successful trading. You can purchase inverse ETFs on many reputable platforms. However, your choice will set the direction of your trade, so make sure to pick wisely.
A good starting point is to read online reviews. This way, you can learn from the experiences of other people. In addition, it will be easier to weigh the pros and cons of the possibilities.
Ease of use is also vital, especially considering that inverse ETFs are aimed at experienced traders. Some platforms will offer a demo account, which is a great way to be familiar with how the system works.
It’s also important for the platform to provide the necessary tools, such as for research. With this, it will be easier to determine what assets are worth the effort. From real-time price to historical data, the platform should provide the necessary information. This will let you make well-informed decisions, increasing the chances of profitability.
More than choosing the right platform, however, a more important consideration is the specific asset to buy. Doing so requires due diligence. Otherwise, you’ll end up losing a lot when you aren’t careful.